<DOC>
[105th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:49151.wais]
HEARINGS ON H.R. 3334, THE ROYALTY ENHANCEMENT ACT OF 1998
=======================================================================
HEARINGS
before the
SUBCOMMITTEE ON ENERGY
AND MINERAL RESOURCES
of the
COMMITTEE ON RESOURCES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
__________
MARCH 19 AND MAY 21, 1998, WASHINGTON, DC
__________
Serial No. 105-92
__________
Printed for the use of the Committee on Resources
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49-151 CC WASHINGTON : 1998
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COMMITTEE ON RESOURCES
DON YOUNG, Alaska, Chairman
W.J. (BILLY) TAUZIN, Louisiana GEORGE MILLER, California
JAMES V. HANSEN, Utah EDWARD J. MARKEY, Massachusetts
JIM SAXTON, New Jersey NICK J. RAHALL II, West Virginia
ELTON GALLEGLY, California BRUCE F. VENTO, Minnesota
JOHN J. DUNCAN, Jr., Tennessee DALE E. KILDEE, Michigan
JOEL HEFLEY, Colorado PETER A. DeFAZIO, Oregon
JOHN T. DOOLITTLE, California ENI F.H. FALEOMAVAEGA, American
WAYNE T. GILCHREST, Maryland Samoa
KEN CALVERT, California NEIL ABERCROMBIE, Hawaii
RICHARD W. POMBO, California SOLOMON P. ORTIZ, Texas
BARBARA CUBIN, Wyoming OWEN B. PICKETT, Virginia
HELEN CHENOWETH, Idaho FRANK PALLONE, Jr., New Jersey
LINDA SMITH, Washington CALVIN M. DOOLEY, California
GEORGE P. RADANOVICH, California CARLOS A. ROMERO-BARCELO, Puerto
WALTER B. JONES, Jr., North Rico
Carolina MAURICE D. HINCHEY, New York
WILLIAM M. (MAC) THORNBERRY, Texas ROBERT A. UNDERWOOD, Guam
JOHN SHADEGG, Arizona SAM FARR, California
JOHN E. ENSIGN, Nevada PATRICK J. KENNEDY, Rhode Island
ROBERT F. SMITH, Oregon ADAM SMITH, Washington
CHRIS CANNON, Utah WILLIAM D. DELAHUNT, Massachusetts
KEVIN BRADY, Texas CHRIS JOHN, Louisiana
JOHN PETERSON, Pennsylvania DONNA CHRISTIAN-GREEN, Virgin
RICK HILL, Montana Islands
BOB SCHAFFER, Colorado RON KIND, Wisconsin
JIM GIBBONS, Nevada LLOYD DOGGETT, Texas
MICHAEL D. CRAPO, Idaho
Lloyd A. Jones, Chief of Staff
Elizabeth Megginson, Chief Counsel
Christine Kennedy, Chief Clerk/Administrator
John Lawrence, Democratic Staff Director
------
Subcommittee on Energy and Mineral Resources
BARBARA CUBIN, Wyoming, Chairman
W.J. (BILLY) TAUZIN, Louisiana CARLOS ROMERO-BARCELO, Puerto Rico
JOHN L. DUNCAN, Jr., Tennessee NICK J. RAHALL II, West Virginia
KEN CALVERT, California SOLOMON P. ORTIZ, Texas
WILLIAM M. (MAC) THORNBERRY, Texas CALVIN M. DOOLEY, California
CHRIS CANNON, Utah CHRIS JOHN, Louisiana
KEVIN BRADY, Texas DONNA CHRISTIAN-GREEN, Virgin
JIM GIBBONS, Nevada Islands
------ ------
Bill Condit, Professional Staff
Mike Henry, Professional Staff
Deborah Lanzone, Professional Staff
C O N T E N T S
----------
Page
Hearing held March 19, 1998...................................... 1
Statements of Members:
Brady, Hon. Kevin, a Representative in Congress from the
State of Texas............................................. 7
Cubin, Hon. Barbara, a Representative in Congress from the
State of Wyoming........................................... 1
Dooley, Hon. Calvin, a Representative in Congress from the
State of California........................................ 6
John, Hon. Chris, a Representative in Congress from the State
of Louisiana............................................... 7
Romero-Barcelo, Hon. Carlos A., a Representative in Congress
from Puerto Rico........................................... 3
Prepared statement of.................................... 4
Tauzin, Hon. W.J. (Billy), a Representative in Congress from
the State of Louisiana..................................... 5
Additional material submitted by......................... 65
Thornberry, Hon. William M. (Mac), a Representative in
Congress from the State of Texas........................... 5
Additional material submitted for the record............. 62
Statements of witnesses:
Geringer, Hon. Jim, Governor of Wyoming...................... 9
Prepared statement of.................................... 46
Hawk, Philip J., President & CEO of EOTT Energy Corp......... 38
Prepared statement of.................................... 287
Leggette, Poe, Esq., Jackson & Kelly; representing the
Independent Petroleum Association of America and the
Domestic Petroleum Council................................. 35
Prepared statement of.................................... 60
Quarterman, Cynthia, Director, Minerals Management Service,
U.S. Department of the Interior, Washington, DC............ 12
Prepared statement of.................................... 52
Schaefer, Hugh V., Director, Welborn, Sullivan, Meck &
Tooley, Denver, Colorado; Chair, Royalties Committee,
Independent Petroleum Association of Mountain States....... 32
Prepared statement of.................................... 55
Additional material supplied:
American Petroleum Institute, Mid-Continent Oil and Gas
Association, The National Ocean Industries Association and
The Rocky Mountain Oil and Gas Association, prepared
statement of............................................... 62
Memorandum to Members and Staff of Subcommittee.............. 283
MMS Second Supplementary Proposed Rule, Feb. 6, 1998......... 280
Royalty Enhancement Act of 1998, H.R. 3334, Section-by-
Section Analysis........................................... 271
Text of H.R. 3334............................................ 223
Hearing held May 21, 1998........................................ 67
Statements of Members:
Cubin, Hon. Barbara, a Representative in Congress from the
State of Wyoming........................................... 67
Thornberry, Hon. William M. ``Mac,'' a Representative in
Congress from the State of Texas, prepared statement of.... 70
Statements of witnesses:
DeGennaro, Ralph, Executive Director, Taxpayers for Common
Sense...................................................... 107
Prepared statement of.................................... 220
Hagemeyer, Fred, Coordinating Manager, Marathon Oil Company.. 93
Prepared statement of.................................... 208
Kalt, Joseph P., Ford Foundation Professor of International
Political Economy, John F. Kennedy School of Government,
Harvard University......................................... 105
Prepared statement of.................................... 316
Leggette, Poe, Esq., Jackson and Kelly....................... 97
Prepared statement of.................................... 217
McCabe, James, Deputy City Attorney, City of Long Beach,
California accompanied by M. Brian McMahon, McMahon and
Speigel.................................................... 103
Prepared statement of.................................... 303
Neufeld, Bob, Vice President, Environmental and Government
Relations, Wyoming Refining Company........................ 95
Prepared statement of.................................... 214
Quarterman, Cynthia, Director, Minerals Management Service... 74
Prepared statement of.................................... 146
Additional material submitted by......................... 405
Smith, Lin, Managing Director, Barents Group................. 108
Prepared statement of.................................... 334
True, Diemer, Partner, The True Company...................... 91
Prepared statement of.................................... 203
Vicenti, Rodger, Acting President, Jicarilla Apache Tribe.... 77
Prepared statement of.................................... 291
Wallop, Malcolm, a former United States Senator from the
State of Wyoming, and Chairman, Frontiers of Freedom
Institute.................................................. 72
Prepared statement of.................................... 117
Additional material supplied:
Mauro, Garry, Commissionar, Texas General Land Office,
additional material submitted by........................... 443
Powell, Ray, M.S., D.V.M., Commissioner of Public Lands, New
Mexico, prepared statement of.............................. 397
Additional material submitted by......................... 412
Reid, Spencer L., Texas General Land Office, additional
material submitted by...................................... 419
Shively, John T., Commissioner, State of Alaska, Memorandum
submitted by............................................... 416
HEARING ON H.R. 3334, THE ROYALTY ENHANCEMENT ACT OF 1998
----------
THURSDAY, MARCH 19, 1998
House of Representatives, Subcommittee on Energy &
Mineral Resources, Committee on Resources,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2 p.m., in
room 1334, Longworth House Office Building, Hon. Barbara Cubin
(chairman of the Subcommittee) presiding.
Members present: Representatives Cubin, Tauzin, Thornberry,
Brady, Romero-Barcelo, Dooley, and John.
STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF WYOMING
Mrs. Cubin. The Subcommittee on Energy and Mineral
Resources will come to order.
The Subcommittee is meeting today to hear testimony on H.R.
3334 to provide certainty for, reduce administrative and
compliance burdens associated with, and streamline and improve
the collection of royalties from Federal and outer continental
shelf oil and gas leases, and for other purposes.
The Subcommittee meets today to hear testimony on H.R.
3334, a bill--oh, excuse me, H.R. 3334, the Royalty Enhancement
Act of 1998 is sufficiently complex that I believe two days of
testimony will be necessary to fully consider the bill.
At this time, I have scheduled a second hearing date for
Tuesday, March 31, to focus on issues not covered today. Also,
some of the witnesses that were scheduled to testify here today
were unable to, due to snow at the Denver airport were unable
to be here, so it is all the more important that we have the
hearing on the 31st.
[The text of the bill may be found at end of hearing.]
Mrs. Cubin. Obviously, significant changes in the manner in
which some $4 billion of oil and gas royalties are collected
each year must be scrutinized very, very carefully. I fully
recognize this, but I am not willing to sit back and do nothing
while states such as mine are asked to bear a portion of the
Federal Government's cost to administer the Federal Leasing
Act.
Our states are given little to say--little or nothing to
say actually--in the management of what is clearly a broken
system for the valuation of crude oil and natural gas. I know
what a difficult issue this is because when I served in the
Wyoming state legislature I was on the committee where we
recodified all of the state statutes on mineral valuation,
taxation and point of taxation.
It is very complicated, but there is no doubt in my mind
that this system that MMS is using is fatally broken. I do not
say that lightly as I understand the magnitude of the dollars
in dispute in various venues around the country, especially
with respect to crude oil.
I would note emphatically at the outset that this bill in
no way--in no way--forecloses the opportunity for private
royalty owners, states or the Federal Government to litigate
questions of alleged undervaluation and payment of royalties
owed.
What Mr. Thornberry has done by introducing H.R. 3334 is to
move us down the road toward designing a system which may
dramatically reduce the costs of collecting royalties. At the
same time, this bill provides an opportunity for adding value
to the public's royalty oil and gas by aggregating volumes and
aggressively marketing the product downstream from the
traditional valuation point which, as we know, is the wellhead
or the lease boundary.
I commend my colleague for the thought that his staff
working with the Subcommittee staff have put into drafting this
bill in an effort to have a fair and equitable bill ocean
everyone.
Did we take advice from the oil and gas industry in the
preparation of this bill? Absolutely. Yes, we did. However, you
will find that prior to introduction the bill was scrutinized
for potential scoring impacts and modified, where in our view a
departure from current practice would have negative
consequences for revenues to the states and to the Federal
Treasury.
Let me reiterate this bill is an attempt to fix a broken
royalty-in-value system which requires extraordinarily
expensive audit and litigation costs upon the government and on
industry alike. Costs which range in tens of millions of
dollars annually. Costs which are factored into the net
receipts sharing formula whereby MMS will reduce payments to
Wyoming by over $7 million in one fiscal year alone.
The Governor told me yesterday that the state legislature,
which just adjourned in Wyoming because there was a $14 million
shortfall, almost had to stay in session another week. Well,
saving this $7 million a year would have taken care of that and
could have avoided the problem altogether.
Costs which are factored into the net receipt sharing
formula whereby MMS will reduce payments to Wyoming by $7
million a year just simply is not acceptable. I do not need to
remind my colleagues about the testimony that we heard from Ms.
Maloney of New York City at our oversight hearing last July
where she spoke of lost revenues for California school children
from alleged underpayment of royalties.
Well, guess what? Wyoming school kids are being denied $7
million under current law, and there are a whole lot fewer of
them to absorb that loss than there are kids in California. In
fact, no state receives a larger percentage of its annual
budget from Federal mineral receipts than does Wyoming.
Therefore, no state has more to win or to lose than Wyoming
does.
Therefore, I am very confident that Governor Geringer, who
is with us today, would not risk revenues due to the state just
to make a few oil producers happy. I know him. I know he would
not do that, nor would I. He and I both will demand
accountability of the industry and the MMS to be sure revenues
are maximized.
I will say now that I have no intention of moving any bill
which does not score positively under the rules of the CBO, and
those rules do not give credit for what should be a greatly
diminished Federal budget for audit and enforcement of an R-I-K
program, I might add. This R-I-K program will replace several
thousand payors on the MMS computer system with, perhaps, a
mere couple of dozen qualified marketing agents.
Furthermore, we have asked for the Interior Department's
input from back in March 1996, when Mr. Thornberry first sought
to have Texas take its Section 8(g) OCS royalty share in-kind.
But, the administration has been unwilling to even contemplate
statutory changes, let alone recommend language saying again
and again that the secretary has all the authority that he
needs. So here we are again in an adversarial position on this
issue. It is an issue that begs for mutual understanding,
cooperation in a relationship between the states and the
Federal Government to get it right for the benefit of the
American people.
I am the eternal optimist, so I am willing to ask one more
time--or maybe two or ten more times, whatever it takes--for
the administration's cooperation and commitment to work with
this Subcommittee and with the states to fashion a workable
system. I will not take personally any criticism of our efforts
to date and I believe my colleagues from Texas will not either,
but neither will I settle for continued foot dragging by the
MMS on the premise that ongoing valuation lawsuits somehow
compel Congress not to act prospectively.
The chair now recognizes the Ranking Member, Mr. Romero-
Barcelo.
STATEMENT OF HON. CARLOS A. ROMERO-BARCELO, A DELEGATE IN
CONGRESS FROM PUERTO RICO
Mr. Romero-Barcelo. Thank you, Madam Chair.
We are pleased to welcome the distinguished guests before
the Subcommittee today. The Minority has not expressed a
position on our colleague, Representative Mark Thornberry's
legislation, H.R. 3334, but we would like at the outset to
commend him for tackling the thorny issue of Federal royalty
management.
It is a very dry and technical area and he needs to be
congratulated for making this effort. It is much more difficult
to be creative than to be critical. Instead of simply attacking
the Federal royalty program, Mr. Thornberry has devised some
comprehensive and innovative alternatives. We owe him a serious
and careful analysis of the bill. So we will not offer a
position at this time.
Instead, we will strive to keep an open mind while
listening to our witnesses discuss the strengths and the
weaknesses of the Thornberry legislation. However, I am
compelled to note that the administration is strongly opposed
to this bill, and would go as far as to recommend a veto if it
were presented to the President. Since Mr. Thornberry has
assured us that this bill is simply a starting point, we look
forward to working with him to craft a bill that is acceptable
to our employers, the American people.
Such a bill will protect the rights and interests of the
United States, and will fulfill the guiding principle of any
royalty program to assure the receipt of the full amount due.
Such a bill will balance the rights of the United States and
its lessors. Such a bill will not relieve lessees of duties
only to unfairly place new obligations on the United States.
Finally, such a bill will be, at least, revenue neutral.
We do have many questions. Preliminary estimates indicate
that the bill, as currently drafted, would cost the government
hundreds of millions of dollars each year. If this is correct,
then the bill must be revised so that we will not lose the
revenues. The Federal oil and gas leasing program is now
raising more than $6 billion a year. Clearly, we cannot
jeopardize those funds.
In that vein, I have asked the Congressional Budget Office
to prepare a preliminary estimate on costs and benefits of H.R.
3334 as introduced, so that we may have the benefit of their
expertise as we in the Subcommittee move forward marking up the
bill. With your concurrence, Madam Chair, I would like to
submit my letter for the record.
I must comment that I appreciate the fact that Madam Chair
has already indicated that it will take CBO's estimates into
consideration, which is something that we must do. That
concludes my opening statement, so we look forward to this
afternoon's hearings.
Thank you, Madam Chair.
Mrs. Cubin. Mr. Thornberry, do you have an opening
statement? I bet you do.
[The prepared statement of Mr. Romero-Barcelo follows:]
Statement of Hon. Carlos Romero-Barcelo, a Delegate in Congress from
the State of Puerto Rico
Madame Chair, we are pleased to join you in welcoming our
distinguished guests before the Subcommittee today.
The Minority has not expressed a position on our colleague,
Rep. Mac Thornberry's legislation, H.R. 3334. But we would
like, at the outset, to commend him for tackling the thorny
issue of Federal royalty management. It is a very dry and
technical area, and he is to be congratulated for making this
effort. It is much more difficult to be creative than to be
critical. Instead of simply attacking the Federal royalty
program, Mr. Thornberry has devised a comprehensive and
innovative alternative. We owe him a serious and careful
analysis of the bill. So, we will not offer a position at this
time.
Instead, we will strive to keep an open mind, while
listening to our witnesses discuss the strengths and weaknesses
of the Thornberry legislation. However, I am compelled to note
that the Administration is strongly opposed to the bill, and
would go so far as to recommend a veto if it were presented to
the President. Since Mr. Thornberry has assured us that his
bill is simply a ``starting point''--we look forward to working
with him to craft a bill that is acceptable to our employers--
the American people.
Such a bill will protect the rights and interests of the
United States, and will fulfill the guiding principle of any
royalty program--to assure the receipt of the full amount due.
Such a bill will balance the rights of the United States and
its lessors. Such a bill will not relieve lessees of duties
only to unfairly place new obligations on the United States.
And finally, such a bill will be, at least, revenue neutral.
We do have many questions. Preliminary estimates indicate
the bill, as currently drafted, would cost the government
hundreds of millions of dollars each year. If this is correct,
then the bill must be revised so that we will not lose
revenues. The Federal oil and gas leasing program is now
raising more than $6 billion a year. Clearly, we cannot
jeopardize those funds.
In that vein, I have asked the Congressional Budget Office
to prepare a preliminary estimate on the costs and benefits of
H.R. 3334 as introduced, so that we may have the benefit of
their expertise as we in the Subcommittee move toward mark-
ing-up the bill. With your concurrence, I would like to submit
my letter to the record.
That concludes my opening statement, we look forward to
this afternoon's hearing.
------
The Hon. June E. O'Neil,
Director, Congressional Budget Office,
Ford House Office Building
Inside Mail
Dear Director O'Neil:
The Subcommittee on Energy and Mineral Resources is holding
hearings this month on H.R. 3334, a bill to change the current Federal
oil and gas royalty system from a percentage of production as a cash
payment to a ````royalty-in-kind'' payment. Under this scenario, the
Federal Government would be required to take all oil and gas royalties
as product and have a marketing agent, in turn, sell the oil or gas on
behalf of the government.
While we are some time away from requiring an actual score on this
proposal by CBO, it would be helpful to receive a preliminary analysis
of the legislation from you.
The hearings are scheduled for March 19 and March 31, 1998. Your
input prior to the second hearing would be most appreciated. A copy of
the bill is enclosed for your convenience.
Should you have questions regarding this request you may call me
directly, or your staff may contact Deborah Lanzone, Resources
Committee at 6-2311.
Sincerely,
Carlos Romero-Barcelo,
Senior Democrat
Subcommittee on Energy and Minerals
STATEMENT OF HON. WILLIAM M. (MAC) THORNBERRY, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF TEXAS
Mr. Thornberry. Thank you, Madam Chairman.
I will not take much time. I just want to express my
appreciation to you and to the Ranking Member and to all my
colleagues on the Subcommittee for their willingness to
consider a little different approach to this, and their open
mindedness to consider if there couldn't be a better way to do
this thing.
I kind of look upon this issue like the tax code mess. It
is so big and complicated nobody has confidence in it. Nobody
thinks that there is a way to write enough tax code regulations
to get proper enforcement. There has got to be a way to cut
through that, to have a simpler fairer system that benefits
everybody. That was certainly my goal.
When we started talking about this two years ago, I was
assured that there was no way that the industry could even come
together because you had big majors, you had independents, you
had oil, you had gas, you had onshore, you had offshore, and
that there was no way that you could have a plan or a proposal
that would work for all of those different situations.
I think we have got one that might just do it, but I am
certainly open and willing to constructive criticism. I don't
have much sympathy for the people who sit out there and put out
press releases and throw rocks, but for constructive criticism
and improvements I certainly want to hear it from any quarter.
So I look forward to working with my colleagues and listening
our witnesses to try to do the best for the taxpayers all the
way around.
Thank you.
Mrs. Cubin. Mr. Dooley, would you like to have an opening
statement?
STATEMENT OF HON. CALVIN DOOLEY, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF CALIFORNIA
Mr. Dooley. Thank you, Ms. Cubin. I appreciate the
Committee allowing me to make an opening statement. I am,
unfortunately, going to have to leave to a conference committee
very shortly.
I just wanted to say that, you know, I applaud the actions
of Mr. Thornberry and the actions of the Committee in giving
due consideration to the royalty-in-kind proposal. I want to
make it very clear that I am a very strong proponent of the
concept which is embraced by royalty-in-kind.
I am so because I think it embraces some principles which
we all should be able to support. I mean, we spend a lot of
time talking about how do we reinvent government over the last
few years and how can we make government to be more responsive
to the needs of different constituencies and making sure that
the government is getting the greatest return to taxpayers for
the investment of the taxpayers' dollars.
I think the royalty-in-kind proposal really can move us
down that path because it, in fact, will put, I think, in place
the appropriate incentives for people who might be marketing
oil that would be given to the government as royalty to
maximize the return on that. We will be ensured that they will
have a vested interest in getting the greatest return to
taxpayers because they are going to have a financial incentive
to get the greatest return for themselves.
Right now, I would have to say that our royalty proposal or
program doesn't necessarily provide for that incentive. I think
that is probably the best protection that the taxpayers of this
country could hope for when you put that financial incentive
into place.
What I think also is very important and it really gets to
the issue that Mr. Thornberry talked about, whether you are a
large producer or a smaller producer, is how do you ensure that
you have equity. I think that this proposal can also ensure
that we are providing equity to producers, to making sure that
they are paying a fair rate, a fair royalty for the oil that
they are producing. It is also ensuring, I think, we provide
equity for the taxpayers, too, because they have certainly a
vested interest in getting a return on what is a taxpayer
asset. I think this royalty-in-kind proposal moves us in that
direction.
I appreciate the fact that we are having this hearing
today, because I think Mr. Thornberry acknowledged that maybe
this legislation is not perfect yet. But, hopefully, at the end
of the day we will hear from some well-informed people that
have some expertise and experience and what are the
modifications that we can make that we can, in fact, make those
proposals something that the administration and all of us can
be very proud of.
So thank you.
Mrs. Cubin. Yes. Mr. Brady, did you have an opening
statement?
STATEMENT OF HON. KEVIN BRADY, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF TEXAS
Mr. Brady. Yes. Madam Chairman, I had not intended to speak
at this point. But my understanding is that earlier today it
was reported that the State of Texas General Land Office is
opposed to this bill. Let me tell you as of an hour ago they do
not believe that is the case. They are not opposed to H.R.
3334. It would be illegal for the agency to oppose legislation.
They have some constructive comments that they are getting to
us and working with us on, which I appreciate.
Let me clarify again Texas and the General Land Office is
not opposed. Let me clarify, too, any perception about the
profits of the Texas program quoting directly from Spencer Reed
of the Texas General Land Office. The Texas Program is
definitely revenue positive. Parts of the program which sell on
the spot market are understandably revenue neutral at times,
but the self-consumption is highly profitable.
Being a former state legislator a year removed, I can tell
you that the biggest part of our public school fund is derived
from oil and gas revenues. We would not trust that important
fund to a program that doesn't consistently produce for us. I
am not going to speak for the General Land Office. They will be
here on March 31 for the hearing, Madam Chairman, and I am
looking forward to their comments.
Thank you.
Mrs. Cubin. Thank you, Mr. Brady.
Mr. John has been speechless since he found out his wife
was going to have triplets.
[Laughter.]
Mrs. Cubin. So I don't know if he has an opening statement,
but he is certainly welcome to make one if he does.
STATEMENT OF HON. CHRIS JOHN, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF LOUISIANA
Mr. John. Thank you, Madam Chairman.
If I start to repeat myself, on the third time please just
stop me.
[Laughter.]
Mr. John. I, too, want to thank my colleague from Texas for
tackling such a very complex issue. It is an issue, I think,
worthy of lots of debate including this forum here today. I
also agree with a lot of the aforementioned comments with my
colleague from California and my friend from Puerto Rico.
I have been in constant contact with the state of
Louisiana, the secretary of natural resources, trying to
understand how this would impact Louisiana, and we are working
through that. But I just look very much forward to this debate
because the merits of this I am in full support of. It is
trying to get through the devils of the details, and that is
what we are here for. I thank Mac for trying to get us to that
point.
Thanks.
Mrs. Cubin. Mr. Tauzin, do you have opening comments?
STATEMENT OF HON. W.J. (BILLY) TAUZIN, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF LOUISIANA
Mr. Tauzin. Well, I certainly want to take a minute again
to congratulate my colleague on what a tremendous triple
blessing he and Payton are going to experience very shortly. We
just got a new puppy, and there is nothing like that.
[Laughter.]
Mr. Tauzin. You are going to have to work hard, I promise
you, Chris. I did want to comment briefly, Madam Chairman, with
reference to this issue because it is one in which it appears
to me the government wants to have its cake and eat it too.
The government wants to be able to allege that in the
marketplace, that in the real marketplace, that companies who
produce oil and gas and other hydrocarbons for their purposes
and government purposes on government lands or not accounting
properly, and they are challenging in court on that basis, for
the fact that they are making more money in the marketplace
when they sell those products than they are accounting for to
the government in royalty. At the same time, they want to argue
this issue that they are going to lose money if they have to
take the product in kind and go into that same marketplace and
sell it.
It seems to me those two arguments are quite contradictory.
If the industry is, in fact, benefiting from selling product in
the marketplace, then the government should enjoy that same
possibility by taking the product in kind and taking it to that
same marketplace, if it disputes the value of the royalties
collected.
It seems to me that what we begin today is a very
worthwhile discussion of which one of those arguments really
holds true in the real world. The bottom line is that
government can today, as I understand it, take its product in
kind if it wants to. If it really believes that companies can
do better in the marketplace, then they should be able to do
better as well.
It occurs to me as we debate this we ought to ask those who
testify to give us some insight as to what happens from the
point of production to the point of sale and what it is about
this process that the government feels like companies are
benefiting in ways that they could not benefit were they to, in
fact, take the royalty in kind and go into that same
marketplace and sell their product. I should think that we are
going to learn a lot, Madam Chairman, in asking witnesses those
kinds of questions, and I look forward to doing so.
My friend Mr. John, I have done some checking with the
authorities in Louisiana as well, and they seem to be sort of
waiting before taking any firm position on the issue. They are
sort of neutral on it because the state has to collect
royalties too. I think they have an interest in knowing a
little more about the issue before they come down solidly on
one side or the other, and I don't blame them.
That is sort of the position, I think, we ought to be in.
We ought to ask the hard questions at this hearing and really
learn how this marketplace works, and see whether or not the
government is really asking to have its cake and eat it or
whether or not the government can and should do better by
taking its product in kind and going out in the marketplace and
selling it, so that we don't have all of these lawsuits about
what is the way to calculate the value because in that world
the government gets its value straight out. It goes into that
marketplace it claims the company is benefiting so royally from
and makes its profit directly in the sale of its product
through its own marketing capacity. So this will be an
interesting discussion, Madam Chairman. I appreciate the fact
that you called this hearing and look forward to it.
Mrs. Cubin. Thank you, Mr. Tauzin.
Now I would like the first panel to come forward. The
Honorable Jim Geringer, Governor of my state and his state--
480,000 of us. I want to welcome the Governor. We served in the
Wyoming Legislature together in the state house and in the
state senate, and now he is the king. But today I am the boss.
[Laughter.]
Mrs. Cubin. Welcome, Governor Geringer. Cynthia Quarterman,
director of the Minerals Management Service of the U.S.
Department of Interior, if you please could come forward.
Could I ask you to rise for swearing in. Raise your right
hand. We do this for everyone.
[Witnesses sworn.]
Mrs. Cubin. Governor Geringer, I would like to call on you
first for your testimony.
STATEMENT OF HON. JIM GERINGER, GOVERNOR OF WYOMING
Mr. Geringer. Thank you, Madam Chairman.
I will at least try to encourage the movement of this at a
fairly and significant pace because I am due out of National
Airport in just a little over an hour so I might be departing
early. If I am not able to answer all of the questions that the
Committee might wish to raise, I will see to it that there are
answers that are brought back to you.
You know, the issue has been framed fairly well around the
table already, Madam Chairman, as to what we are hoping to do
through this. If we could find a better way to administer
programs through government or through the states or through
some other process, then we ought to all look at that, and that
is the intent of speaking in favor of H.R. 3334 today.
There are many indications that perhaps this may not be the
perfect bill. There seldom has been a bill written perfectly or
we wouldn't be back every time year after year to bicker about
it. But the concepts that have been illustrated so far, for
instance, Wyoming receives about $200 million a year in royalty
payments. The Federal Government receives at least that much,
and that is part of the contention that we have. I say ``at
least,'' because there is more than that accrues to their
pocketbook through a process called ``administrative costs.''
To my knowledge, no state nor the Federal Government have
has ever taken a company to court for selling something too
high. There is always a contention that it has been sold too
low or valued too low, and that deliberation goes on and on. It
is a very expensive litigation process and appeals process.
I am very pleased that Representative Thornberry has taken
it upon himself and co-sponsored with yourself and
Representative Brady this particular legislation to move an
issue along. It certainly needs remedying.
In Wyoming, we take the royalty payments and share them 50
percent with the schools and the other half goes to various
local governments. So this is something that is definitely the
underpinnings of the most fundamental part of our society.
H.R. 3334 would simplify the royalty collection process,
decrease administrative cost for both the MMS and industry,
thereby increasing the net payment to the state to provide
certainty and royalty valuation, and decreases the cost of
audits and the subsequent appeals and still achieves a fair and
equitable market value for the product.
We have been frustrated for some time that we do not have a
simple and fair method to value oil and gas for royalty
payments. Some producers and leaseholders work very hard to be
objective and above board in the valuation of the product at
the lease, others are not as forthcoming, and instead they
devise all sorts of third party marketing transactions and
camouflage the real market that is out there. It is difficult
to tell who is right and who is wrong, and rather than
assigning blame why don't we just take a simpler approach. That
is what this bill endeavors to do.
We are frustrated also with the charges that are being made
from the Federal Government to the states to administer the
current system. Wyoming receives its 50 percent share of
Federal mineral royalties on a net receipts sharing basis,
which means that we suffer a deduction of 25 percent of the
cost of administration.
It has not always been that way. It has only been lately
that the MMS has assigned that cost to the states because their
own costs have increased significantly. We do not like the high
cost of Federal administration, and so I propose to Assistant
Secretary Armstrong that Wyoming be allowed to take its royalty
share in kind rather than in cash and avoid having to pay at
least the $7 million per year that we lose from the Federal
collection and administration.
Now, if the Federal Government could receive the same or
greater income from Federal in-kind royalties as it would
receive from traditional royalty payments, it seems like a
slam-dunk that we should go forward with this. That is our goal
in supporting this particular bill.
There have been several studies from the General Accounting
Office, from the Department of Interior IG's Office within the
state of Wyoming to determine the true costs of administration.
Wyoming contends that we can accomplish the administration of
the royalty program for one-seventh of the cost, that when we
have attempted to have detailed disclosure of the cost
breakdowns from the MMS we do not get those in a way that we
can do a one-on-one comparison.
The GAO stated that we could not compare both programs
because their tasks were so completely different. We disagreed
with the GAO's conclusion. The task of monitoring leases,
production, valuation, and collection of royalties are no
different on a state lease or a Federal lease, and we do both.
The state of Wyoming still does the auditing for many of
the leases that the Federal Government has undertaken. There
will be a written designated agent for the last--I believe it
came in in 1983, so about 15 years. In fact, we have saved the
Federal Government through our collections and auditing $50
million just in the last 11 years alone, so we already know how
to do it.
They have acknowledged that by renewing the contract with
the state every year. States know how to do it, and they do do
it very well. For whatever was said at the press conference
this morning, I think the facts speak for themselves that the
states are significantly capable of handling this. One of the
proposals for the marketing of the in-kind oil or marketing of
anything or to calculate valuation would be based on NYMEX
pricing.
As I looked at the oil price this morning as it was posted
for Wyoming production, some of the postings are based on a
NYMEX price, but most of the Wyoming posted is based on what is
called the West Texas intermediate. The Wyoming valuation has
dropped significantly. There is another reason, Madam Chairman,
for why we in Wyoming are proposing the opportunity to take
royalty in kind.
If the state of Wyoming is able to contract with a
qualified marketing agent and aggregate all of its production
or at least a significant portion of whatever is economically
feasible, we could aggregate it because it is going through a
third party. It would be truly at arm's length.
We would encourage a lot of our independent producers in
Wyoming who are currently suffering mightily at the drop in oil
prices--they are about to shut in their wells--rather than shut
in all of these marginal wells, which nationally could amount
to 20 percent of the entire production of consumption of the
United States' petroleum, if those wells were shut in, they
likely would not be brought back in.
That has a significant impact on our national security and
our future as far as the control of the costs, or at least the
opportunity to have an influence on the cost of that
production. If we can keep our small independent operators
going through an aggregation process where they can bid in and
ask the same agent to aggregate their product and thereby
increasing the total volume, the benefits accrue all across the
board. We all benefit. So, it is a true partnership that could
evolve out of the system. I see so much potential there that it
certainly ought to be evaluated, and so I speak in favor of
that.
The state should be able to continue to retain its 50
percent, but it should be on a gross proceeds basis rather than
net proceeds. We should not have to argue over whose valuation
or whose administrative costs are deducted. Let the state have
the sole option whether or not it wants to take on the program.
The state should be able the use a qualified marketing agent.
The state should enjoy all of the benefits of the Federal
Government.
The bill, Madam Chairman, does state that on page 10 under
Section (b)(1): ``The state shall enjoy all the rights and
assume all of the obligations that the United States would
otherwise have under this Act.'' That is all that we are
asking. It is a pretty easy concept. If the states are willing
to take it on and want to do it, let them do it.
The MMS has proposed pilot programs and have proposed one
in Wyoming which we have supported, at least in concept. The
actual process and procedure we are not in full agreement on,
but we ought to acknowledge that there are ways that we could
do it to demonstrate whether or not such a program would work.
I believe that the best chance for success is to let the
real experts market the oil and gas in order to get the best
price. MMS believes that they should be allowed to do the
marketing and I question whether they have the expertise to do
that marketing.
I appreciate Cynthia Quarterman's and MMS's intent work
with our state in developing a pilot project, but I do point
out that there is a big difference between being a joint
partner where we jointly develop the process, the procedure,
the standards and just being full what it will be, kind of like
a take-it-or-leave-it partnership. I like one where we truly
benefit from each other's expertise and capability.
In summation, Madam Chairman, as you move the legislation,
I urge that you ensure the legislation at least maintains the
opportunity for royalty in kind to be allowed by the Federal
Government, that the states be able to opt in at their sole
discretion, that the Federal Government do contract with a
qualified marketing agent so we know we have a true market-
oriented transaction, that the option for the states to elect a
contract with a qualified marketing agent on behalf of
themselves should be maintained.
The intent to keep audit requirements simple and
nonduplicative and the goal overall to reduce government costs
and increase return to the Federal and state treasuries, that
really is our goal. If there were a simpler way to do this, we
would be advocating that. Absent any other way to establish
valuation for the product that is being considered, I urge you
to consider a way to give us that opportunity so that we can
determine whether or not we can enjoy greater income for the
benefit of both the Federal Government and the state government
and certainly for the children who benefit from that allocation
to education.
Thank you, Madam Chairman. Oh, Madam Chairman, for the
record if there might be any question as to what the Wyoming
proposal is on the pilot project, I would like to submit for
the record an exhibit that shows as of March 25, 1997, what we
have transmitted as the Wyoming proposal to take state share of
Federal royalties-in-kind oil. If that could be entered along
with my comments, I would appreciate it.
Mrs. Cubin. Without objection. Thank you, Governor.
Ms. Quarterman?
[The prepared statement of Mr. Geringer may be found at end
of hearing.]
STATEMENT OF CYNTHIA QUARTERMAN, DIRECTOR, MINERALS MANAGEMENT
SERVICE, U.S. DEPARTMENT OF THE INTERIOR, WASHINGTON, DC
Ms. Quarterman. Good afternoon. Madam Chairwoman and
members of the Subcommittee, I appreciate the opportunity to
appear today to present testimony on H.R. 3334 and on our
implementation of programs to take oil and gas royalties in
kind. I will briefly address the RIK legislation before
providing a progress report on our three pilot projects.
At the outset, I would like to make our position on RIK
legislation clear. We do not believe that legislation is needed
to exercise our contractual rights to take royalties in kind.
The Mineral Leasing Act, the Outer Continental Shelf Lands Act
and the lease agreement with the producers all grant us the
option to take our royalties in kind. The Department,
therefore, strongly opposes any legislation mandating the
United States to take mineral royalties in kind.
I would like to also clarify our position on RIK
implementation. As I testified last year before the
Subcommittee, we are genuinely excited by the potential of RIK
programs to streamline and improve aspects of our Royalty
Management program. Accordingly, we are aggressively working on
an ambitious schedule to implement our three RIK pilots.
There is no inconsistency in these two positions. We
strongly believe that the realistic test of RIK under actual
conditions are needed prior to any legislative decisions on
broader implementation. RIK is unproven for the royalty
collection in the United States. As stewards of public assets,
we must have assurance that the revenue and administrative
effects of RIK are at least revenue neutral before moving to
implementation.
I hasten to remind this Subcommittee that the one instance
we have of testing, taking royalties in kind resulted in a loss
of revenue. A legislatively mandated RIK program would
eliminate the value of being able to choose which collection
method in-kind or in-value works best in each location.
I will limit my discussion of this bill to just a few
general reactions. As a whole, this bill would force the United
States to relinquish many of its long-established legal rights
as lessor while relieving lessees of many of their equally
long-established obligations. The collective result of the bill
is to drastically reduce the options and legal rights of the
Federal Government. We all must seriously ask ourselves how it
is to the advantage of the citizens of the United States to
give up these rights, and as a result a substantial part of the
value received for our nation's nonrenewable resources.
There are many specific components of this legislation that
would act to decrease the value of Federal mineral royalties.
While we haven't fully analyzed this bill, we believe the
details of the bill will have substantial revenue and legal
impacts. The more damaging aspects of this bill to the public
interest are, first, the Federal lessor would assume cost of
marketing oil and gas in a royalty-in-kind program where
production is sold downstream of the lease.
Under in value royalty collections currently in effect, the
Federal Government has not participated in such costs. So
unless we can somehow make the production more valuable than it
is now, royalty revenues to the Federal Treasury will logically
and unambiguously decline under RIK.
Second, we have identified several unfavorable conditions
under which RIK programs would reduce revenues. These
conditions include taking diminimus volumes in remote areas,
taking production at less than marketable condition and paying
above market rates for transportation. This bill mandates RIK
under all of these unfavorable conditions, we believe, ensuring
a revenue loss.
The bill would statutorily adopt many of the positions
taken by the oil and gas industry in historic disputes with the
Department on valuation gathering, field processing and
transportation. Disputes, I might add, that have been
consistently won by the Department. This would be an
unjustified economic gift to the lessee. We must be careful not
to effect legislation or rulemakings, for that matter, that
serve only the special interests of either lessee or lessor.
We at MMS regard our program initiatives in valuation and
in-kind royalties as completely independent efforts. However,
it has become increasingly apparent that some view these
efforts as directly related. Specifically, we are told that RIK
is needed because MMS is increasingly establishing royalty
value at downstream locations and abandoning gross proceeds as
a valuation basis.
That is simply not the case. We have taken very seriously
the concerns raised on these aspects of our rulemaking. In our
recently published crude oil valuation proposal, we have
presented five valuation principles we use as our basis
including that royalty obligations for arm's length contracts
should be based on gross proceeds received under such
contracts.
For the record, I just want to clarify the lease
requirement that a lessee has a duty to market at no cost the
lessor since it has been so often misunderstood. It does not
mean that we will second guess a lessee's decision not to
market downstream. MMS does not participate in the marketing
decisions of the lessees. It does not tell the lessee how to
market. Accordingly, it does not participate in its cost.
Now as for our RIK pilot projects, last summer we decided
to implement RIK pilot projects in Wyoming, offshore Texas and
the Gulf of Mexico. I am pleased to report that we are
currently making great progress in implementing those
recommendations.
We are on course to begin the Wyoming crude oil pilot this
October. From the outset we have been developing the pilot in a
close and cooperative partnership with the state of Wyoming. I
understand that the state will decide after an early April
briefing whether to include state volumes in the project as
well. Governor Geringer and I will receive the same decision
briefing from the RIK implementation team.
Governor Geringer, I want to assure you that we will not
implement a project, a pilot project, in your state without
your support.
Mr. Geringer. Good.
Ms. Quarterman. Regarding the Texas pilot, we are working
with the state concerning implementation of RIK for natural gas
from offshore 8(g) leases in the Gulf of Mexico. We also expect
that pilot to begin this October.
Lastly, we are quite excited about the prospects of our
outer continental shelf in-kind project in which we will take a
substantial portion of royalty gas from the Gulf of Mexico and
use marketing agents for its management and disposition. The
size and complexity of this project dictate that we take
another year before we can begin with confidence. The startup
date is said to be October 1999.
These projects form a logical, deliberate process that
tests RIK across a broad array of Federal lease and production
situations. Our hope is that these tests will allow us to
implement the al-
ready-existing RIK option in the best manner and under the
right circumstances. This spells success not only for royalty
management, but for the taxpayer as well. In contrast, we
strongly believe that implementation of this bill without first
discovering its real impacts and actual programs is unwise.
In closing, our message today is that this bill represents
a dramatic transfer of cost and obligations from the oil and
gas industry to the Federal Government. Our preliminary
analysis suggests that the revenue lost would be significant
and could be as much as half a billion dollars.
Because of the effect of this bill on the taxpayer and the
budget, the Department will recommend that the president veto
H.R. 3334 or any bill that requires mandatory RIK.
Thank you, Madam Chairman and members of the Subcommittee.
I would be happy to address any of your questions.
[The prepared statement of Ms. Quarterman may be found at
end of hearing.]
Mrs. Cubin. Thank you, Ms. Quarterman.
I think I will start my questioning with the Governor. We
will have two rounds of questioning, so I will just focus on
the Governor for right now.
As Chairman of the Interstate Oil and Gas Commission, a
compact commission in Wyoming, I understand that you and your
staff have taken a look at both the pros and the cons in our
RIK program. Can you tell me what the commission has concluded?
Have they endorsed a concept for a Federal mandate for
royalties in kind?
Mr. Geringer. Yes. Madam Chairman, the Interstate Oil and
Gas Compact Commission represents 36 states either as direct
members or as affiliates. We have worked cooperatively since
1935 to address energy conservation and regulation of the
industry. That association is very familiar with the cost as
well as the process that is involved with oil production and
certainly conservation, because we consider our primary role to
be one of conserving the resource and not letting it get out of
hand.
The commission unanimously approved a resolution in the
December meeting to support the development of a comprehensive
and flexible royalty-in-kind program for both oil and gas. The
resolution also supports allowing a producing state at its sole
option to assume those marketing and administrative functions
designated to the Federal Government, which this legislation
would allow.
The association does not just blindly pass resolutions. It
is a tough nut to crack to get a resolution through that
organization, but they have indicated their willingness to
support this and the 36 members and affiliates spoke in favor
of that.
Mrs. Cubin. In your testimony, you make reference to a
study that the state of Wyoming did on the administrative
process associated with the collection and distribution of
mineral royalties. Can you elaborate a little bit for me on
that study and tell the Subcommittee what cost savings your
study predicted if a state like Wyoming were to manage its own
royalty program?
Mr. Geringer. Well, Madam Chairman, it has been a bit of a
difficult process because we have never been able to obtain a
full accounting for how the Federal deductions come about. We
did com-
plete a study of our own as to what we thought the projected
cost of administration of a state-operated program would be, so
we know what our costs are. They come out to be about one-
seventh of what we are being charged by the Federal Government.
There must be something that could be learned from a full
disclosure as to what the costs are and why the deductions are
as high as they are.
In October 1997, the Department of Interior IG's Office
issued a report of the MMS Service, the BLM and the USDA Forest
Service. They analyzed the expenses that were charged against
Federal royalties in the context of net receipts for three
fiscal years, 1994 through 1996.
The conclusion of that report was that the states had been
overcharged. So there is an IG's report that at least says
overcharging does occur. We think that there could be
considerably more at stake than what the IG's report turned up,
and we have asked the secretary of interior to refund those
overcharges to Wyoming. I believe New Mexico has also asked the
same thing.
Mrs. Cubin. Since you do not have any information to the
contrary, is it correct for me to say that you assume that the
cost savings that the state could make would be comparable in a
royalty-in-kind program?
Mr. Geringer. That is certainly our goal, Madam Chairman. I
think any reasonable person would say that based on the
indications that we have through our own analysis, through the
IG's report and just for the sheer frustration of not being
able to consistently come up with an answer to what the value
is at the lease--nobody markets at the lease, yet we have to
calculate a value at the lease--I guess, as I said earlier, the
logic seems to be overwhelmingly in favor of some sort of an
RIK program, which if an individual state wants to take it on,
it is a reduced cost to MMS. The opportunity to enhance
royalties for both the state and the Federal Government is
there. I mean, that is a no lose situation.
Mrs. Cubin. Ms. Quarterman, can you tell me why the states
have not been able to get the information, the statistics, that
they need to know exactly what the costs are that MMS spends on
collection?
Ms. Quarterman. We have provided the states with detailed
accountings of all of our costs.
Mrs. Cubin. Then why doesn't the Governor understand it?
Ms. Quarterman. I can't answer that one.
Mrs. Cubin. Do you agree with that, Governor?
Mr. Geringer. Madam Chairman, if we could have a side-by-
side comparison of why the costs are allocated as high as they
are and so much higher than what the equivalent costs would be
on a state lease, if you take single lease in a unitized field
or something that is comparable close by, you ought to be able
to have a side-by-side comparison. When Wyoming runs its cost
out and it comes up that much higher, why are they that much
higher?
Mrs. Cubin. Could I ask you both here today to make a date
to sit down at the table and compare those figures and work
that out? I think that is something that is very important for
the Committee to know before we would move forward. Would you
both commit to doing that?
Mr. Geringer. I certainly would, Madam Chairman.
Ms. Quarterman. Our figures are open for anyone to look at
our costs, absolutely.
Mrs. Cubin. No, no, no. Would you sit down at the table and
go side by side with the Governor and his staff, your staff and
make a comparison?
Ms. Quarterman. Oh, certainly.
Mrs. Cubin. OK. Now it is a date, don't forget. I see that
my time is up.
Mr. Romero-Barcelo?
Mr. Romero-Barcelo. Thank you, Madam Chair.
First of all, I want to welcome the Governor here to the
hearing and ask a couple of questions.
Mr. Geringer. Thank you.
Mr. Romero-Barcelo. Governor, according to the President's
basic budget documents, approximately $7 million that would
otherwise go to Wyoming is used to offset the Federal
Government cost in order to run the Federal longshore oil and
gas leasing from which Wyoming is entitled to an equal share of
the gross receipts.
We understand that the state of Wyoming has strong
objections to the net receipt sharing program in which the
states pay a portion of the Federal Government's cost to
administer the onshore oil and gas leasing program. Under H.R.
3334, Wyoming would no longer share in the Federal Government's
cost to run the onshore program.
Have you considered the possibility that states could lose
even more than they are now paying under the net receipts
sharing because the gross revenues would be reduced by paying
for things that the Federal Government does not now pay under
the current law like marketing, transportation, processing, and
aggregating?
Mr. Geringer. Madam Chairman, if the state of Wyoming had
the opportunity to take its product in kind, there would be
very little to account for at the Federal level with the 1,800
employees that are currently at MMS. Perhaps in a rather crude
analogy or comparison, the Province of Alberta in Canada has 67
employees to administer an in-kind program where they have
contracted with a third party to market almost an equivalent
amount of product. Sixty-seven employees in Alberta compared to
1,800 employees in MMS, there is probably something in between
that could be counted as savings to both parties.
Mrs. Cubin. Excuse me for interrupting, Mr. Romero-Barcelo.
The Governor has a plane to catch at 3:30, and so I thought I
would ask the panel if they would object to submitting written
questions to him if they have any further questions. Would that
be all right with the panel and with the Governor?
Mr. Geringer. If there is any burning issue that needs to
be answered right away, Madam Chairman, I would sure stick
around for one or two questions; but, yes, I do appreciate your
indulgence in trying to burn a little jet fuel here.
Mrs. Cubin. Are there any burning questions from the panel?
[No response.]
Mrs. Cubin. Thank you. Thank you very much for your
testimony, Governor Geringer.
Mr. Geringer. Thank you, Madam Chairman.
Mr. Romero-Barcelo. Madam Chair, I have 10 questions that I
want to submit in writing.
Mrs. Cubin. Absolutely. The record will certainly be kept
open to get those.
Mr. Geringer. Madam Chairman, we do want to indicate our
willingness to work with MMS, with Ms. Quarterman and with this
Committee at whatever markup is done on the bill because I
think we can mutually benefit from how we come out of this.
This is not a choice of whether the states versus the Federal
Government can do a job better. It is an indication of what we
might do together that has a mutual benefit for us both. It is
not an either/or, but it is how we might mutually benefit from
whatever comes out of this legislation. So thank you for the
opportunity.
Mrs. Cubin. Godspeed, Governor.
Mr. Barcelo, would you like to--we will add some minutes on
to your time since I interrupted you.
Mr. Romero-Barcelo. No, that is all right. I can submit my
questions to Ms. Quarterman also in writing.
Mrs. Cubin. Well, we are going to have two rounds of
questioning, so if you want to start with questioning Ms.
Quarterman, that is fine.
Mr. Romero-Barcelo. I have got 13 questions here. I think I
would just as soon submit them in writing, so we can save some
time. We have quite a few members and other panels.
Mrs. Cubin. OK. Good.
Mr. Tauzin?
Thank you, sir.
Mr. Tauzin. No questions, Madam Chairman.
Mrs. Cubin. Mr. Thornberry?
Mr. Thornberry. Thank you, Madam Chairman.
Ms. Quarterman, I appreciate you being here. I tell you the
truth after you called last night I was a little disappointed
in the tone of your remarks of your testimony. I certainly
never expected the administration to support a mandatory in-
kind bill.
You make it clear on the first page of your testimony, that
the issues about whether you have authority to do it or not
indicates that you would not accept it. I understand that a
mandatory royalty-in-kind bill reduces the size and power and
control of MMS. I never had any question about whether that
would be something that you or your Agency could support.
I had hoped all through this process that there could be a
more constructive dialog about how if there were going to be an
RIK program, how it could be done in a way that makes sense for
everybody. I have got to tell you I am particularly concerned
about some aspects of your testimony that do not appear to have
anything to do with the bill that we introduced. There are
several instances.
On page 6 of your testimony, you talk about that the bill
would mandate RIK programs in areas where unfavorable
conditions--and one of the conditions you referred to was
taking production at less than marketable condition. That does
not apply to our bill. You mentioned that H.R. 3334 would
require MMS to pay above market rates for transportation. We
changed that. We took from your geothermal regulations the
method of computing the transportation costs, so that does not
apply.
On page three of your testimony, you have a number of
things listed there that were in the industry draft but were
not in my bill as introduced.
The fourth thing you have on page three says that the
bill's criteria--that they could sell to themselves, that the
companies could sell to themselves, or affiliates are so broad
and enforceable that it would be a problem. We let the
secretary set up the rules on how that can be done.
I am a little perplexed, I guess, as to whether in your
testimony your staff was working off of the industry draft or
the bill that was actually introduced. The difficulty is that
also makes it somewhat difficult to have a real dialog and
constructive comments about how to do this thing in the best
interest of the taxpayers and everybody who is involved with
it.
Let me get to one issue at least beginning, and that is,
this question of whether or not MMS can take royalty-in-kind
now under existing authorities. I have got before me ``Minerals
Management Service Royalty Gas Marketing Pilot Final Report,''
September 1996, which indicates on page 27 that ``The OCSLA
fair market value provisions preclude us from proceeding with a
new pilot or program without a change for gas royalties in
kind.'' Then I have also got from your September 2, 1997, press
release a statement that ``Most Federal mineral leases contain
a provision that permits the government to receive its royalty
share in kind.''
Now, have your lawyers sorted out whether or not MMS with
no existing authorities can require royalty in kind mandatory
across the board for all leases?
Ms. Quarterman. Well, first, Mr. Thornberry, I want to
assure you that my staff did have a copy of H.R. 3334 before
them, and I did note that there were changes between the two
bills, the industry version and your version. Attempts may have
been made by your staff to correct some of the things that are
listed in my testimony; however, they are not corrected in that
bill.
With respect to the statements made both in the report and
the press release, lawyers were neither on the team that put
together that report or involved in the writing of that press
release. It is my understanding that we have legal authority to
proceed.
Mr. Thornberry. That would be discretionary to you on
whether to do it and how to do it currently. These two things
are wrong. In your view, you have the discretion on when and
how and in what circumstances to take royalty-in-kind?
Ms. Quarterman. It is my understanding the law does give us
that discretion.
Mr. Thornberry. OK. Madam Chairman, I will reserve until
the next line of questions.
Mrs. Cubin. Mr. John?
Mr. John. Ms. Quarterman, in your testimony you had talked
a lot about--well, a little bit about the pilot programs. I saw
an optimistic look on your face and in the inflection in your
voice. Can you share with us what you see the problems that you
are going to encounter that we might be able to learn and
incorporate in the piece of legislation that we are proposing
or looking at, at this point in time? Because you are in what?
Two of 3 years in the Wyoming pilot and progressing in each of
the other states?
Ms. Quarterman. Yes.
Mr. John. Give us where you see where we can maybe look at
some of the problems?
Ms. Quarterman. We have taken royalty-in-kind. In 1995, the
Federal Government took about 6 percent of its gas offshore in
kind, and there was an extensive study done--maybe the one that
Mr. Thornberry is referring to--that listed some of the
problems that we had in that study where we lost 6 percent of
our revenues.
Mr. John. Why? Give reasons.
Ms. Quarterman. There were a number of reasons. I can give
you a handful of them, but probably not all of them. I haven't
read it recently. One of the things that we thought was
problematic was that we took our gas in kind at the beginning
of the year. We thought that it would make more sense to do it
at the beginning of the heating season.
Secondarily, the way we handled the pilot, we turned it
over directly. We, essentially, sold it to a marketer to sell
later on in which case we really do not have the opportunity to
carry the gas to a further point downstream. We see that as a
problem.
Another problem was that we did this very, very quickly. We
did have a great deal of involvement by gas marketers, the Gas
Supply Association, oil and gas industry associations because
we did not really know what we were doing and we wanted to make
sure that what we wrote in a contract with a marketer was
something that was akin to what an oil and gas company would
write in a contract with a marketer. We did not want to put in
any hidden ugly things that would cause us to reduce value.
Those are some of the things.
Some of the others, transportation cost was another. What
we found was that our marketer bid on certain production of
gas. When it came time to accept the gas and move it to the
marketplace, he had not taken into account the fact that there
are many nonjurisdictional pipelines along the way and he would
have to negotiate with each individual owner of those pipelines
a nonpublic rate along the way, so he had not included those
costs. We had a couple marketers drop out after they had
submitted bids because they had overbid the situation. Since it
was a pilot, we thought it was appropriate to do that.
Mr. John. There are some critics and research on this issue
that say some of the problems you have encountered with some of
these pilot programs are obviously in the marketing area, and
you have touched on that. Are those problems a result of your
office trying to be the marketers in those situations?
Ms. Quarterman. We have never tried to be the marketer. We
certainly do not have the expertise to do that.
Mr. John. OK.
Ms. Quarterman. Some might think that is an interesting
idea maybe to start a quasi-government corporation that markets
oil and gas.
Mr. John. No. That is not what I am suggesting here.
Ms. Quarterman. It is not what we are suggesting either,
but it is an idea.
Mr. John. Thank you.
Mrs. Cubin. Mr. Brady?
Mr. Brady. Thank you, Madam Chairman.
In your testimony, you identified a figure of a half a
billion dollars as the cost to American taxpayers for this
bill. I know you are a very knowledgeable executive, so I know
I can ask you these questions with confidence.
Those figures, do they include taking advantage of the best
practices of current marketing, that is, using qualified
marketing agents versus unqualified marketing agents who are in
a learning curve?
Ms. Quarterman. Yes. This assumes that the government would
hire the best marketers available. I mean, we are talking about
an extremely large amount of oil and gas production. I do not
think we should settle for anything less than the best in those
circumstances.
Mr. Brady. I am reading the testimony from Governor
Geringer and I understand that to date you are not planning to
use a qualified marketing agent in that state; is that correct?
Ms. Quarterman. In the Wyoming pilot, we had two options
available to us: one was to do a competitive bid, and the
second was to do a qualified marketing agent. The team working
on that which did include Wyoming representatives thought it
was a good idea to try to look at both of those methodologies.
I have since learned that the Governor's office does not
support the competitive bidding portion of that; and if that is
the case, we will drop it out of our pilot.
Mr. Brady. The only reason I ask is that obviously the
private sector has found that having qualified real experts, as
the Governor identified them, marketing is the key to enhancing
the value. If past practice from the Agency has been to not use
them, it is easily assumable that the estimates used today
would be assuming you are not using the best in the field in
the future.
Ms. Quarterman. In our pilot where we actually did take gas
in kind in 1995, I think you would find that we used the best
marketing available.
Mr. Brady. Within the existing one? Just so I understand,
there is one in effect?
Ms. Quarterman. Actually, we haven't started taking any oil
in that pilot at this point.
Mr. Brady. May I ask, have you talked to any qualified
marketers in that pilot program?
Ms. Quarterman. Not to my knowledge.
Mr. Brady. Does the $500 million figure include the
reduction in any regulatory auditing or litigation costs as a
result of being part of the market versus chasing it?
Ms. Quarterman. I said close to half a billion dollars.
That figure includes a deduction of about $6 million, which is
MMS's share of net receipt sharing costs that are currently
paid by all the states combined as a deduction in terms of
increases for administrative costs. I think the chairwoman
alluded to earlier those sorts of things are not typically
scorable administrative savings.
Mr. Brady. For the most part, it does not include that
reduction?
Ms. Quarterman. I can give you a broad estimate of that.
Our current royalty management program costs approximately $60
million. Our best guess at this time is that if this bill were
to pass, and I think that it requires a year's time before it
is actually imple-
mented, given the Royalty Simplification and Fairness Act that
passed a couple of years ago we would probably need to have all
of our auditors on board for 7 years beyond the date anything
was put in place in order to take care of the statute of
limitations period that is currently pending.
Other than oil and gas production, we do collect royalties
on behalf of about 20 tribes and 20,000 allottees that would
also have to continue to go on. We collect geothermal, coal,
solid minerals, any number of things. Our best guess would be,
assuming that everything disappeared in 7 years of those things
that are currently associated with oil and gas, about a $32
million reduction.
Mr. Brady. Does the figure include the acceleration of
royalty receipts now lost to the time-consuming delays in
litigation and dispute?
Ms. Quarterman. Currently, if a delay occurs because of
litigation, the company is required to pay, assuming that we
win, if there is a delay they pay interest on that so there is
no time value of money loss involved.
Mr. Brady. You do not collect during that period?
Ms. Quarterman. We do not collect during that period for
any moneys that are carried over, correct.
Mr. Brady. Is it safe to say that is not included in the
figure?
Ms. Quarterman. That would not be included in the figure.
It would be very small.
Mr. Brady. A couple of quick questions. I assume you
included the risk costs in the analysis. Can you tell us what
figure you assigned to the enhanced value of the oil and gas?
Ms. Quarterman. First, I should say that the number that I
mentioned is a beginning number in that it only is really
associated with the items that I mentioned in my testimony.
There are a number of other items that we have not at this
point tried to define the value. One included is the cost of
risk. I am not sure how we would value such a risk.
Mr. Brady. I do not mean to interrupt, but I assume you got
$500 million by figuring in certain costs and certain risks and
certain expenses associated with it. My question is, What
figure did you use as a result of what the real goal of RIK is,
which is the enhanced value of the product? I know you want to
balance out. You do not want to count just one and ignore the
other.
Ms. Quarterman. OK. There is no risk cost yet in that
number, so the number would potentially increase in terms of
potential loss. As to potential uplift, I do not believe there
is any uplift that we can measure at this time. The Federal
Government currently has the authority to take its oil and gas
in kind at its option, which means that forcing it to do
something that it already can do does not include any uplift.
If we were to do an estimate, we would have to go back to the
natural gas pilot in which we lost money, and that would be a
further negative.
Mr. Brady. You would ignore the reams of real life data
occurring in the private market today and would go back to a
fairly flawed pilot program in order to ascertain the numbers?
Ms. Quarterman. I am not aware of the data that you are
referring to.
Mr. Brady. Thank you, Madam Chairman.
Mrs. Cubin. Mr. Tauzin?
Mr. Tauzin. Madam Chairman.
Ms. Quarterman, I am trying to follow your statement. When
you say the results of your pilots would allow you to select
the areas where an RIK can produce additional net revenues, and
to avoid those areas they will lose revenue. You say that is
not an inconsistent--there is no inconsistency in these two
positions. Let me see if I can interpret that and you can help
me with it.
What I read is that you are saying where you, as the
government, can take royalty in kind and the transportation and
marketing costs are low enough risk for you to go out and
market it and make more money doing so that you want the right
to do that. On the other hand, when the transportation and
marketing costs may be too high, you want the right to put that
cost on the oil company and to take the value added without
taking the risk. Is that a fair assessment of your position?
Ms. Quarterman. Well, I would say a couple of things. You
know, in my role as director of the MMS I have not only the
Royalty Management program, but also the Offshore Minerals
Management Program off of the Coast of Louisiana. As part of
the broader picture of things, one of the things I have to
balance is not only receiving fair--not maximum, but fair
market value on behalf of the taxpayers--but also to lease
areas that we think are appropriate for leasing.
Mr. Tauzin. Ms. Quarterman, I am going to be limited in
time. I understand you have got a lot of roles to perform, but
I would just like an answer to the question. Am I correct in
assessing your statement that you are saying that the
government should have the right in cases where transportation
and marketing costs may be high to take the value added in
terms of royalty calculation without having to pay the cost of
transportation and marketing, to put the risk on the oil
company? Is that what you are telling us in your statement?
Ms. Quarterman. Sir, what I am telling you is that the
government has that right.
Mr. Tauzin. You are saying that the government has the
right under current law----
Ms. Quarterman. Yes.
Mr. Tauzin. [continuing] to literally tell an oil company
that, ``You have to pay all the cost of marketing and
transportation and the government will then get the added value
at your expense at no risk to the government. But if we want
to, we can go in the market where the conditions are more
favorable and take that added value at our own expense in
transportation and marketing''? In short, you are saying that
the government has the right to interpret the contracts you
have with oil companies in a way that is most always beneficial
to the government; is that correct?
Ms. Quarterman. We do allow for transportation costs. I
just did not want that to get lost there. The government does,
both in the OCS Lands Act and the contract with the companies,
have the right at its option to take royalty in kind or in
value.
Mr. Tauzin. I understand you have that right. I am saying
that you are telling us, as I understand it, that the current
law allows you to interpret the contract with the oil company
that is drilling on Federal lands and interpret it in such a
way as to always interpret it in favor of the government and at
the expense of the company?
Here is my problem. My problem is not just with the
enormous cost of all of this auditing and the lawsuits that are
flowing out of it and the disputes over whether or not
marketing costs should be allocated or not allocated in the
discussion of royalty payment, the problem I have is that there
are three possibilities here.
One is that Congress passes a law clearly defining the
rights of the government and the rights of the citizen who is
leasing government property for the production of minerals; or
the contract specifies those terms is the second option and
specifies them very clearly, who is responsible for the cost of
transportation and marketing; or the third option is for the
bureaucracy of our government to interpret a contract at will,
at its discretion, to always take the benefit for the
government out of that contract.
It seems to me that that is the least favorable option for
us in fairness to the citizens who participate with the
government in the production of its minerals, that the best
situation is either one or the other two. Either the contracts
ought to very clearly say what the right of the government is
and what the right of the oil company is in regards to how
costs are allocated, or the Congress ought to say it.
What we are being asked to do is to continue a status quo
where the government is constantly trying in intricate,
complicated rulemaking to determine value as against cost in
contracts that are not apparently very clear, that are blind in
a lot of these areas, where the government will always try to
interpret it to the benefit of the government, and where we end
up with diagrams of government rulemaking that look like
Dungeons and Dragons to me, if this is an accurate
interpretation of what the rule actually requires.
When we have a choice of doing one or two things, passing a
bill that clearly defines the right of government and the oil
companies so that there are no more disputes and no more audits
necessary, or requiring the government to specify its rights
clearly in a contract.
Madam Chairman, I will wrap up. I know my time is up. I
simply want to say this. It seems to me untenable for us to
continue a process where the government has to keep going to
court arguing that costs should be allocated one way or another
in the process of fixing values or that values ought to be
assessed at some gathering point, at some wellhead, or at some
downstream point, at the refinery, or perhaps all the way to
the gas station when either the contracts ought to make that
clear or we ought to make it clear in the law.
One of the very easy ways to make it clear in the law, to
get rid of all of this auditing and all of these lawsuits and
all of this conflict between what should be partners,
government and citizens in partnership to develop minerals for
our country on Federal lands, when the very simple thing to do
is to say to the government, ``Take your share of it, hire a
marketer and market it yourself and get your value.'' Then,
nobody has a complaint anymore about what the value is.
To let the government have the best of all worlds, to take
the higher value when it suits you and then force the oil
company to eat all the costs when you think that helps your
situation is to me an untenable situation that leaves for the
bureaucracy the interpretation of what ought to be the law
between the parties as defined by the contract or by the law.
Thank you, Madam Chairman. I have gone over.
Mrs. Cubin. That is fine.
Dr. Quarterman, I want to start out by saying that I have
always been very impressed and appreciate your professionalism
and your knowledge of the issues and your willingness to work
with the Committee to cooperate on information.
I do want to followup on some of Mr. Thornberry's comments
however. I was just kind of amazed because when he started
talking about the fact--or the opinion, I guess, that the
testimony you have submitted seems more related to the industry
draft rather than the bill that is before us, that was exactly
what I thought.
As I read through your testimony once and then I read
through it again, and it was so nonspecific and it was so vague
that to try to gain any kind of way that we could come together
to solve problems that are perceived is really impossible. For
that reason, I am going to have to ask you to come back on the
31st for the hearing on the 31st.
I realize you probably did not write that, those remarks
yourself, but really in my opinion they really are inadequate.
For example, you said, ``Well, yes, we did,'' your comment was,
``Oh, yes, we did use the right bill,'' but there was not
anything discussed or explained about transportation, gathering
costs and return on investments in pipelines.
On the top of page three, you mentioned paying above-market
prices for transportation. But as we will discuss at the second
hearing as well, definitions of gathering transportation and
return on capital investment was significantly modified from
the industry's draft, I should say. We view this bill as a
return to current practice. It also allows the secretary plenty
of discretion on how to disallow deductions on a lease-by-lease
basis.
I am disappointed. Since we did not get this, your
testimony, until 5:30 last night we did not have the
opportunity to get in touch with you and ask for more
specifics, things that were more directly related to the bill.
I know that we are likely to disagree here today on the
central question of the so-called duty-to-market issue, but we
will hear the witnesses to follow you today are quite sure that
such a duty is not historical practice as your testimony
suggests. They and many others believe that MMS is now seeking
to move the valuation point downstream to ensure that the
government will receive, as Mr. Tauzin referred, additional
revenues without accepting any risks. Could you respond to that
for me?
Ms. Quarterman. I am sorry, what is the question again?
Mrs. Cubin. Well, there will be witnesses that will be
following you that are going to say that there is not a
historical practice of duty to market, and that MMS is now
seeking to move the valuation downstream to capture added value
without accepting any of the risks or associated costs. I would
just like your response to that.
Ms. Quarterman. It is my understanding that historically
there has always been a duty to market that the government has
not born, that lessees have born and that the law is pretty
clear on this issue, that there really is not much to argue
about. There have been cases related to it, and the government
has consistently won them. I am not sure what else there is to
say on that one. I am not going to say that I have done any
great legal research on this either, because I have not.
Mrs. Cubin. You said, this is a quote, ``Our preliminary
analysis suggests that the revenue loss would be significant
and on the order of hundreds of millions at a minimum.'' Again,
incomplete information. Over what period of time?
Ms. Quarterman. Per year. If I could, on your earlier
statement. I would be happy to come back before the Committee
on the 31st or any other time you deem appropriate. One of the
things I did mention to Representative Thornberry last night is
that we have not had the opportunity to do a detailed analysis
of the bill line by line, which is something we want very much
to do and are in the process of doing and will have done by the
31st. It was also my understanding that that hearing would deal
with transportation issues, technical transportation issues,
and those sorts of things. I will be happy to come back. I do
not know if I am the best person to talk about that level of
detail, but I will try.
Mrs. Cubin. I can relate to that. Bring your experts along
with you. This is the last thing because I am over my time and
Mac is giving me the evil eye. It distresses me that the
alleged failure to make money in the 1995 gas pilot project in
the Gulf keeps cropping up as it has here today.
You would acknowledge that there are lots of mistakes made
in designing that pilot, but I see one big problem, which is
that the government took the gas at the lease and then
immediately sold it. It did not flip the gas, and therefore did
not get the value added from downstream marketing efforts. That
is what this so-called uplift which we want to earn for the
states and Federal Government is, just for what it is worth.
Mr. John, do you have a second round of questioning?
Mr. John. No, Madam Chairman.
Mrs. Cubin. Mr. Thornberry?
Mr. Thornberry. Thank you, Madam Chairman.
I guess I would like to use my time just to get as much
factual information as you have available to you on what basis
you made the statement that the potential to lose money in the
order of hundreds of millions of dollars. No. 1 is, What
baseline did you use, did you operate from? Is it the existing
rules? Is it your new proposed rule? Where did you start from?
Mrs. Cubin. The existing rules.
Mr. Thornberry. What is the biggest factor that you
included in your estimate that you believe would lose money
under an RIK proposal? What loses the most money and what you
have looked at so far?
Ms. Quarterman. Transportation costs, I believe.
Mr. Thornberry. OK.
Ms. Quarterman. I would have to verify that.
Mr. Thornberry. Do you have a figure there handy?
Ms. Quarterman. It is the changes to the transportation
provisions between $97.5 million to $246 million.
Mr. Thornberry. OK. From $97 million to $246 million is the
range?
Ms. Quarterman. Is the range, yes.
Mr. Thornberry. OK. Just briefly, you are talking about an
increased cost to the government for transportation costs that
the qualified marketing agent would have to assume, or are you
talking about a reduction in cost that the government now gets
reimbursed by the oil company?
Ms. Quarterman. A reduction in cost over the current rules.
Mr. Thornberry. Which the government currently is paid in
some fashion?
Ms. Quarterman. In some fashion, yes.
Mr. Thornberry. By the oil company. That range is $97
million to $246 million. What is the next item?
Ms. Quarterman. Again, these numbers are very preliminary.
Mr. Thornberry. But if you use them, I want to know how you
got there.
Ms. Quarterman. Between $61 million to $158 million on
processing changes.
Mr. Thornberry. This starts to get into at what stage in
the marketing chain you sell the product? The change from the
current practice, your estimate is that it would be that much
of a change?
Ms. Quarterman. Yes.
Mr. Thornberry. OK. What is the next item?
Ms. Quarterman. Oh, between $17 million and $46 million on
the change to the marketing requirements.
Mr. Thornberry. OK. Explain to me the difference in how you
calculate the change in processing and the change in marketing?
Ms. Quarterman. Processing is something that lessees
currently have to do to put the product into marketable
condition. ``Marketing'' means taking the product to market
whatever costs may be associated with aggregating production,
that kind of thing.
Mr. Thornberry. OK. All right, what is the next item?
Ms. Quarterman. That adds up everything that we have gotten
to thus far. There are other things that we do not have a value
on at this point.
Mr. Thornberry. My understanding from your answer to Mr.
Brady's question was that you have no increase in value because
of any uplift?
Ms. Quarterman. That is correct.
Mr. Thornberry. My understanding is also you have no value
in there as a result of reduced administrative costs,
litigation costs, and so forth?
Ms. Quarterman. That is correct.
Mr. Thornberry. Now, I noticed in your testimony you made
some comments about how the cost of marketing would be shifted
from the lessee to the Federal Government under an RIK program.
Does that argument play into these cost figures that you have
given me?
Ms. Quarterman. The item that I listed that said marketing,
that is the element.
Mr. Thornberry. That is where that fits in?
Ms. Quarterman. That is where it fits in.
Mr. Thornberry. OK. When making an assumption like that,
what is your assumption on how a qualified marketing agent will
be paid or reimbursed for his services? How do you figure that
it will happen to get this estimate?
Ms. Quarterman. I do not have the details of that. I would
be happy to provide that to you when we get closer to a final
number.
Mr. Thornberry. Well, let me just offer this. Did you
consider the possibility that some qualified marketing agents
may be willing to market the Federal Government's share of oil
for nothing so that they can aggregate a larger volume of
crude, and therefore have a more valuable product to sell?
Ms. Quarterman. I have heard some put forward that
viewpoint. In my experience, people are rarely willing to do
something for nothing.
Mr. Thornberry. Even if it is of value to them?
Ms. Quarterman. It is a value that is usually taken out of
the other person's hide, I would suggest.
Mr. Thornberry. The bottom line is we do not know from your
estimates how you assumed the marketing costs would be,
although you do have a number, a gross number, but we do not
know how that has arrived at?
Ms. Quarterman. I cannot tell you now what that number is
or what went into that calculation, no, that is correct.
Mr. Thornberry. OK. Thank you, Madam Chairman.
Mrs. Cubin. Mr. Brady?
Mr. Brady. Madam Chairman, staying on that sheet, if we
could, you have identified a number of expenses and costs and
reductions. Shifting to the other side of that, can you read me
the items and dollar figures for enhanced value and increased
revenue under RIK?
Ms. Quarterman. Zero at this point. As I explained earlier,
we have the authority to do it at this point in time. I cannot
imagine a scenario under which there would be an uplift, given
the fact that we have no experience to know that.
Mr. Brady. Now, in earlier testimony before the Committee,
you talked about the potential of RIK and today you talked
about the potential of RIK to increase revenues under the right
conditions. Is it safe to say that you included no enhanced
value? You didn't include the savings of self-consumption by
Federal agencies either, which has been very successful in
Texas where basically Federal facilities or Federal agencies
use the oil and gas in kind to reduce their own costs? Was that
on the balance sheet at all?
Ms. Quarterman. Well, I think the operative word in my
testimony has been ``potential,'' we have not in fact seen it.
We have in the past spoken with both the Defense Fuel Supply
Corporation and the GSA which are responsible for supplying gas
primarily to a large segment of the Federal Government to the
Defense Department. I spoke with them about the opportunity of
taking gas in kind. They really had no interest in taking our
gas because they got a better deal elsewhere.
Mr. Brady. I will finish with this, Madam Chairman.
Just so I understand, is it safe to say you have a
completely negative analysis of this impact with absolutely no
positive impacts? Ignoring what is occurring in the
marketplace, ignoring your earlier testimony about potential,
ignoring what states and other entities have received in
enhanced value, is it safe to say your analysis while
preliminary is completely negative?
Ms. Quarterman. Is it safe to say that, yes.
Mr. Brady. I do respect your knowledge and your homework.
If you could, send us those figures.
Before the next hearing, Madam Chairman, if we could get
those in advance so we have an opportunity to review them
ourselves that would be a great help. Obviously, we are all
trying to get to a point where we increase revenues for
taxpayers, and so those numbers are important.
Ms. Quarterman. I would be pleased to provide them.
Mr. Brady. Thank you. I appreciate that.
Thank you, Madam Chairman.
Mrs. Cubin. Mr. Tauzin?
Mr. Tauzin. Well, I would like to make maybe a different
point, though, and that is: it is one thing to say the
government will not get some money, but it is another thing to
say whether or not the government is entitled to that money. If
the government does not get some money it is not entitled to, I
do not have a problem with that. It is a little bit like, you
know, if we had a piece of land we wanted to build a building
on and we told the contractor you go build a building and you
be responsible for the cost, we will just enjoy the building.
I do not think the taxpayers of America would appreciate
the government treating the contractor that way. What I am
saying is you can do an evaluation that says the government may
not come out as well if it has to bear some of the cost of
marketing and transportation, if it wants the benefits of a
higher price at some other point than the point of delivery of
the product, but it is another thing to say that the government
was entitled to that money without an express agreement by the
parties or some law saying that that was going to be the law
between the two parties when the lessor and the lessee agreed.
You know, that is my problem, Ms. Quarterman. It is not
just a question of what the dollars are, it is a question of
what the equities are here, No. 1. No. 2, isn't there a simpler
way of doing this than this extraordinarily complex rule for
setting values that takes us to court all the time? It is
looking more like the IRS. That is my problem. I mean, maybe
worse.
If you end up having to have an oil evaluation rule that is
so complex because it has to take into account every kind of
different scenario in the world--commingling, transportation,
aggregation, exchange, and whether or not a company is dealing
with an affiliate or a nonaffiliate with its transaction or
not--when you start having to deal with so many different
scenarios to try to figure out a rule to assess their value,
the cost of doing that in regulations, the cost of doing that
in disputes or the courts, the cost of deciding in the end what
the value is adds up considerably.
I saw you asked for additional moneys for your Department.
I would hope the extra $5 million is not just to enforce this
rule, but I would think it is probably related. I mean, this is
getting pretty complex. It just seems to me that maybe the RIKs
are ways in which we can solve this in a more simple, more
satisfying way for both the parties if we define who is
responsible for cost somewhere along the line. It seems to me
that, you know, some definition of what the lessee is
responsible for and then where the lessor picks up the product
and is responsible from then on is a fair way of doing that.
In regards to the RIK you have done, the pilots you have
done, did you seek the counsel and the advice and the
cooperation of the companies in designing these pilots, or did
your Agency do them on your own?
Ms. Quarterman. Absolutely, we worked hand in hand with the
oil and gas industry in developing these pilots.
Mr. Tauzin. They were contributors to the design of these
pilots? Because I am told otherwise, that they did not have as
big a hand as perhaps they might have wanted to have in making
sure the pilots were good examples of what might occur. Are you
telling me you think they did?
Ms. Quarterman. Oh, absolutely.
Mr. Tauzin. The pilots that you are running indicate to you
that at least on some occasions the government can make money
when it takes royalty-in-kind; right?
Ms. Quarterman. Not at this point we have not had that
indication. We are extremely hopeful. I would like to think
there is an opportunity for RIK, and that is precisely why the
government is running these pilots.
Mr. Tauzin. In fact, I have seen some of your quotes
indicating that, in fact, you not only have a lot of hope, that
you think it is very logical that the government will do well
at least in certain cases where RIKs can work for the benefit
of the government; right?
Ms. Quarterman. Yes, there are certain cases that are
appealing at least on the face.
Mr. Tauzin. You are not ready to say that your pilot
programs have disproved that yet?
Ms. Quarterman. Our pilot programs haven't started other
than the one that we had in 1995 in the Gulf.
Mr. Tauzin. You are literally making your projections of
losses without the benefit of the knowledge you might gain from
these pilot programs?
Ms. Quarterman. We are making our losses based on the
legislation versus current situation. As I said, we have
nothing other than the 1995 pilot where we lost money to
determine whether or not we would make money here or not.
Mr. Tauzin. There are theoretical losses based upon the
notion that if the government had to always take its product in
kind from the gathering point and then be responsible for
transportation and marketing costs in the process that it would
lose money.
My only conclusion, then, you must be saying what I
initially thought you said in your report, that you thought it
was OK for the government to allow the lessee to bear all of
those costs and bear risks and have the government take the
benefit of the extra value downstream; is that correct?
Ms. Quarterman. They are not theoretical losses. You know,
I want to be clear. We do not think that in taking royalty in
kind or in value there is any detriment to the oil and gas
industry. They are required by law to allow us to take it
either in value or in kind. If we take our oil in value, they
must provide us with fair market value unless this Congress
decides to change that.
Mr. Tauzin. Yes, but it is not that simple. The question is
when do you value it? Where do you value it? If you insist that
you value it at some point downstream after the company has
absorbed a lot of cost and risk in marketing as opposed to
valuing it at the point when it is deliverable to the
government as an in-kind situation, that is a big difference,
is it not? Isn't that the difference in your numbers?
Ms. Quarterman. That is not what is in my valuation
rulemaking.
Mr. Tauzin. Isn't that in your numbers of losses?
Ms. Quarterman. I am sorry?
Mr. Tauzin. Isn't that difference really where you get your
numbers of losses?
Ms. Quarterman. The difference in losses is between the
current regulation, the current way things are operating, and
the way things would change under RIK because there would be
changes in the way we look at transportation, the way we look
at processing and other kinds of things.
Mr. Tauzin. Well, you look at who bears the cost of it is
what you are saying?
Ms. Quarterman. Precisely.
Mr. Tauzin. Thank you.
Mrs. Cubin. Thank you.
We certainly thank you for your time and your testimony
here today. I just want to request one last thing. First of
all, I want you to know I think geothermal energy certainly is
an absolutely essential part of the nation's overall energy
supply. I also realize that far, far less money is at stake in
geothermal than in the RIK program that we are talking about.
When we come back on the 31st, I would appreciate it if you
would please be prepared to fully discuss why H.R. 3334
provision regarding return investment on transportation, say,
like, a pipeline in the Gulf of Mexico isn't fair? We modeled
that provision exactly upon the geothermal or what the
geothermal gets, which is two times the Standard and Poor BBB
return on investments. I would appreciate an explanation of why
that is not fair when you come back on the 31st.
Ms. Quarterman. I will be happy to do that. I should say
geothermal and the oil and gas industry are different. We do
have different standards for valuing transportation costs in
the oil and gas industry. We would be happy to provide those
figures, so you have an apples to apples comparison.
Mrs. Cubin. I certainly realize that it is different. I do
not exactly understand why transportation would be different,
but we will make that clear on the 31st. Thank you very much
for your testimony. Maybe I can be more specific in the
information we would like you to provide on the 31st.
Thank you very much.
Now I would like to call the second panel: Mr. Hugh
Schaefer, the director of Welborn, Sullivan, Meck and others,
the Independent Petroleum Association of the Mountain States;
Mr. Poe Leggette of Jackson & Kelly representing the
Independent Petroleum Association of America and the Domestic
Petroleum Council.
Mr. Hawk, since the witness that was to be on your panel
was not able to get here due to weather, I would ask you to
join this panel as well. Mr. Phil Hawk, President and CEO of
EOTT Corporation.
If you would, stand so that I can swear you in.
[Witnesses sworn.]
Mrs. Cubin. Thank you.
Let me remind the witnesses that under our rules your
testimony, your oral statements should be limited to 10
minutes, but your entire written statement will be included in
the record. We will start the testimony with Mr. Schaefer.
STATEMENT OF HUGH V. SCHAEFER, DIRECTOR, WELBORN, SULLIVAN,
MECK & TOOLEY, DENVER, COLORADO; CHAIR, ROYALTIES COMMITTEE,
INDEPENDENT PETROLEUM ASSOCIATION OF MOUNTAIN STATES
Mr. Schaefer. Thank you, Madam Chairman.
My name is Hugh Schaefer. I am chair of the Royalties
Committee of the Independent Petroleum Association of Mountain
States, which I will refer to simply as ``IPAMS'' throughout
the rest of my presentation. IPAMS is a nonprofit, nonpartisan
association representing over 700 independent oil and gas
producers, service/supply companies, and industry consultants
in the Rocky Mountain region.
IPAMS appreciates the opportunity to appear before you
today and present this statement. We believe that there is a
distinct need for relief from the current royalty in-value
system. There are significant advantages to be gained by
requiring the Federal Government to take its oil and gas
royalties in kind rather than in value and avoid the wasteful,
time-consuming, and complex process that is involved with the
determination, payment and auditing of Federal royalty
payments.
Until the recent enactment of the Federal Oil and Gas
Royalty Simplification and Fairness Act, most audits were not
commenced until an average of 4 to 5 years after the royalty
payments in question had been made. Thereafter, a lengthy
administrative appeal process delayed the final resolution of
MMS royalty claims, assuming that the lessee disputed the audit
claims and sought administrative relief. This 3 to 4 years was
just what it took to get the case through the Department of the
Interior.
IPAMS believes that a royalty-in-kind program will
eliminated a substantial portion of this time-consuming delay
in the resolution of audit disputes. Although the Fairness Act
has speeded up the audit process with a 33-month rule,
nonetheless the Federal Government still has 7 years in which
they can file a royalty claim for underpayment of royalties or
be time barred by the statute.
Now, under the current royalty-in-value system, a lessee
who appeals a royalty payment has an election either to pay the
disputed royalties under protest and subject to appeal or post
a surety bond or irrevocable letter of credit. If the lessee
elects the later, then any Federal royalty revenues are going
to be postponed until the appeal process is exhausted. If the
lessee elects to go to court and post another bond, then again
Federal royalty revenues are being denied.
Now, I realize that the bonding process requires that there
be a bond to cover both principal and interest for one year in
advance, but this is a rolling type of bond where each year the
accrued interest is rolled up and put into the principal.
We believe that if the royalty-in-value program remains in
place the audit process will become even more exacerbated and
difficult to administer, because new and proposed royalty
valuation regulations have become more and more complicated and
difficult to administer for the small independent oil and gas
producer.
They will create more cost and effort to apply these new
regulations properly, effectively and efficiently. They will
also require the employment of qualified personnel or
consultants to do this work for Federal lessees. This
additional cost becomes particularly onerous when industry goes
through periods of price volatility such as we are experiencing
now.
I do not have to tell you, Madam Chairman, that we all know
what the price of crude oil, Wyoming sour and Wyoming asphalt
is today. It is somewhere between $7 and $8 a barrel. As you
mentioned earlier in your opening comments, I can testify my
clients are shutting in their fields because this is not an
economic return for them.
As you are all aware, the MMS gas transportation allowance
regulations have recently been challenged in Federal court.
That challenge has been mounted for the very reason of which I
have just spoken. It is a complex regulation. It is difficult
to administer. As we get new regulations on oil and also on gas
valuation, I believe that it is a distinct possibility that
these, too, may end up in litigation. Now that is not intended
as a threat, but it is just my educated guess.
I want to talk a little bit about these proposals because
the whole thrust of my presentation today is that I honestly
believe that there is even now in the current regulatory system
a shift away from traditional methods of valuing oil and gas
under Federal leases.
In my remarks, I pointed out that, for example, the Mineral
Leasing Act has always been that the value of production in
wells are at the well, in the field or area. Then the approach
that is being taken now, even though the regulations are just
merely proposed or haven't even been proposed, is that we are
already beginning to see ``a netback'' approach, that is: to go
to a downstream market and net back from the sales point or the
delivery point back to the wellhead.
In the cases that I have observed, and I should say I have
presently on appeal to the director or the Interior Board of
Land Appeals, not all of these prices have even been adjusted
properly to reflect the transportation differential. This is
very interesting be-
cause back in 1988, now we are looking at these regulations, we
went through all of this before.
I would suggest that, with all due respect to the
Committee, if you have time, to go back and look at the 1988
regulations. You are going to see that all of this got ironed
out before, the affiliate issue, and now we are coming back all
over again. As Yogi Berra said, it is ``Deja vu all over
again.'' We are going to go through this again.
The other thing I want to mention is that recently the
industry and MMS and the states have been working on developing
a gas valuation regulation. We have gone through iteration
after iteration for 3 to 4 years, and we still do not have a
gas valuation regulation. I expect that we will have one, but I
also expect it is not going to be very well received by the
industry and possibly even the states. As I mentioned earlier,
it could very possibly lead to litigation.
Now at this juncture I want to describe a couple of cases
which point up the flaws in the current audit process. I have
several of them enumerated in my comments, and I recommend them
to you for your reading. The first example involves a small,
independent affiliate who does, in fact, have a marketing
affiliate.
Let me just digress for a moment to say that the marketing
affiliate has risen to the fore because of the way in which
natural gas is being marketed today. We no longer sell gas at
the wellhead to an interstate pipeline company. The FERC
through its Order 636 reorganized and unbundled the whole
pipeline marketing system so that now it is incumbent upon a
producer to go to an end-use customer and find a market for
that gas.
Most independent oil and gas producers were not equipped to
do that because that was something they left to the pipeline.
Now they have to turn and use these marketing affiliates. It
makes a lot of business sense that if you can afford to have
your own marketing affiliate do this work you are going to save
money because it is going to cost you more money to hire
somebody who is independent. That only makes sense.
Now, in this case my client sold gas to its marketing
affiliate, and we were unclear under the regulations as to how
that gas should be valued when we sold it to our marketing
affiliate. Now, let me say this is a marketing affiliate that
buys and sells not only its own affiliates' gas but gas of
third parties, so it is not what I would call an ``MMS
marketing affiliate.'' Under MMS regulations, an ``MMS
marketing affiliate'' is one that deals exclusively with gas or
oil that is produced by its own affiliate.
The request was denied. Well, let me back up. My
affiliate--or my client, excuse me, wanted to use as a value
basis prices, index prices, on gas transmission lines in the
field or area. That was declined. We received an order to
comply with the existing regulations. We proceeded to file the
new reports and pay the additional royalties in.
A few years after that, we were audited. The auditors came
in and disregarded and rejected the valuation methodology and
force ordered my client to pay on the basis of prices that were
being received in the end user market and netting back to the
wellhead. In fact, this is unclear, but I am told by my client
that the auditors did not even know about the valuation order
until they showed up at the doorstep and they asked, ``What are
you doing here? We have already paid these royalties.''
In another case--this is truly a tragic story--my client
received an order to pay, appealed the order to the Director of
the MMS, the order was upheld, appealed to the IBLA.
Unfortunately, the proofs of service, the certified mail
receipts which under IBLA regulations must be filed to show
that the appeal was timely filed, were lost.
The lessee sued the law firm that filed the ``Notice of
Appeal'' and won a judgment for malpractice. The point being
that the auditors confused gas volumes that would be excluded
because the gas was being put to a beneficial use and with a
cost that a lessee is not allowed to deduct for gathering,
dehydrating, cleaning the gas and everything like that. That
cost that law firm $250,000, because that is the amount of the
additional assessment. I see I am out of time. My comments have
a lot more in it, and I will be happy to answer any questions.
[The prepared statement of Mr. Schaefer may be found at end
of hearing.]
Mrs. Cubin. Thank you Mr. Schaefer. Your entire comments
will be part of the record.
Mr. Leggette?
Mr. Leggette. Leggette.
Mrs. Cubin. I knew that.
STATEMENT OF POE LEGGETTE, ESQ., JACKSON & KELLY; REPRESENTING
THE INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA AND THE
DOMESTIC PETROLEUM COUNCIL
Mr. Leggette. Madam Chairman, it is my pleasure to be here
to conduct a very brief but magical history tour of Federal
royalty law relevant to the bill before you today.
In 1929, the Federal onshore leasing program was only 9
years old, but already the Department of the Interior suspected
that oil produced in the Kettleman Hills in California was
being valued for royalty purposes at less than its fair market
value, so the Department took its royalty share in kind.
Instead of receiving $1.65 per barrel in value, Interior
received $2.25; and $2.54 cents per barrel for the barrels that
it sold.
Then the Department changed its tactics. It ordered the
Federal lessees in the field to pay royalty in value, and to do
so using the highest posted price anywhere in California for
oil of like gravity. The secretary believed he had the implied
power under the lease and under his regulations to set the
value of oil for royalty purposes. He sued the lessees to prove
his point, and he lost.
In United States v. General Petroleum Corporation, the
trial court held that when leasing the Department's role is
like that of a private landowner. For the secretary to have the
power unilaterally to set the value of oil, that power must be
expressly stated in the lease or regulations. The Department
appealed this point, and again it lost. The Ninth Circuit Court
of Appeals ruled in 1950 that unless the power is expressed the
secretary does not have it.
Independents have reviewed the numerous Federal lease forms
going back to 1920 when the Mineral Leasing Act was enacted and
the regulations going back to that date. There is no express
power in the lease or rules allowing the secretary to require
lessees to market oil or gas at no cost to the lessor.
I believe that Ms. Quarterman, in talking about court cases
that she said were to the contrary, must have been referring to
a separate duty, the duty to place oil and gas in marketable
condition at the lease--a duty that this bill does not change.
The case I just discussed, by the way, is the only court
case that the Department of the Interior has pointed to in
support of its claim that there is an implied duty to market
beyond the lease at no cost to the lessor. Obviously, we think
the Department's position is not well founded.
Well, my history tour is over, but the question remains the
same today. Royalty in kind or royalty in value? Once again,
the Department's preference is for royalty in value. It has
proposed to overhaul its current rules for oil. It says that
this change will bring certainty and simplicity. I now invite
the Committee's attention to the charts to my right.
This is an illustration of the decision tree that one would
have to go through to apply the current proposal. I am not
going to bore the Committee with a detailed description of
this. What I would like to point out is that every blue or
yellow box is a decision point. The ovals that look like gears
in a Charlie Chaplin movie, at least that is what I wanted to
say until I heard you refer to it as ``Dungeons and Dragons''
and I think that is much better, but that is the point where
MMS has to make a determination.
What is really important to understand here is that all of
the yellow boxes are subjective decision points. These are the
ones where neither the lessee nor the lessor have certainty.
There are more yellow than blue boxes. For MMS to assert that
this proposal is simple and certain is simply and certainly
inaccurate.
I must also respectfully disagree with Ms. Quarterman on
another point that she stated, and that is this. The proposed
rule is expressly drafted to allow MMS to use this new duty to
market to second-guess an independent producer's decision to
sell its oil at arm's length at the lease. The Kettleman Hills
case was litigated for over 11 years. You can imagine what fun
lawyers are going to have with this proposed rule. There is a
better way.
Diemer True, president if IPAA's Land and Royalty Committee
was prepared to outline it for this Committee; however, he
cannot join us today because of a heavy snowstorm in Wyoming.
He sends his apologies. He will testify on March 31. On behalf
of independents, we submit his statement for the record today.
With your leave, Madam Chairman, independents would like me
briefly to touch on the highlights of his testimony.
Mrs. Cubin. Can I interrupt you just for a second, so that
I do not forget to do this later. Since I have sworn in the
witnesses, I would prefer that you not submit his testimony for
the record today. He will be here on the 31st to do that
himself.
Mr. Leggette. My offer is withdrawn.
Mrs. Cubin. Please do go ahead and summarize the testimony
as you started to do.
Mr. Leggette. Thank you. Independents support H.R. 3334,
the Royalty Enhancement Act. Independent producers agree that a
mandatory royalty-in-kind program will once and for all
eliminate the disputes and uncertainty inherent in any royalty-
in-value program.
This bill could not have been introduced at a better time.
World oil prices have sunk to levels not seen since 1986. If
America is to maintain a viable domestic oil and gas program,
we need Federal programs and policies that encourage industry
to grow. The lower prices drop, the harsher the impact of the
costs of royalty compliance are on independents. This bill
would allow us to redirect money from royalty compliance to
investments in exploration and production. The bill will be
revenue-neutral at worst. I think you all have guaranteed that.
From the general design of the bill, I believe it will be
revenue positive. You have already heard our friends in the
Department say the opposite. I know that. But their view is
based primarily on the assumption that they are going to
succeed in creating this new duty to market at no cost to the
lessor. We invite them to bring their budget scorecard to the
table and to work with us to create a winning solution for the
country.
Please consider all of the cost savings this bill can
bring. The government's cost of administering the royalty value
program would largely be eliminated. Using private marketing
expertise to market Federal royalty oil, the government can
maximize its revenue without creating a new Federal marketing
bureaucracy to replace the current royalty value bureaucracy.
Independents are ready to work with the Committee, with the
administration and interested skeptics to refine the bill, to
minimize the government's costs without unfairly assigning them
to producers. Independents urge Congress to proceed with the
passage of the Royalty Enhancement Act, and we ask proponents
of the status quo to work with us in developing a successful
program.
In closing, I would like to offer the Committee a personal
perspective that it will not receive from any other witness. I
am the only witness today who has served in the front lines of
the Federal royalty wars on both sides, 11 years with the
government and 8 years in private practice. I know how both
sides see the issue and I know how both sides feel, and it
worries me.
Never has the level of distrust between the Federal lessor
and its lessees been greater. The emblem of the government's
distrust of lessees is its decision to use the bludgeon of the
False Claims Act in an effort to impose on lessees retroactive
changes in royalty policies. The emblem of the lessees'
distrust of the government is their enthusiasm for this bill--
an enthusiasm that, in my view, would have been unthinkable
just a few years ago.
Distrust has its costs. In making a business decision, a
smart business person like Mr. Hawk has to consider many
tangible things, but also the intangible factor of how reliable
he feels the party on the other end of the contract will be.
Right now, lessees do not believe their lessor is reliable.
That means that money that would be invested in marginal
Federal oil and gas prospects will instead be invested
elsewhere, and that means less revenue to the state and Federal
Governments.
I was disappointed to learn that the Department has argued
that independents support the Royalty Enhancement Act as a
diversionary tactic. That is very wrong. The Act is not a means
of diversion; it is a means of salvation for the Federal
leasing program, for it will eliminate the single greatest
cause of distrust between lessee and lessor. Independents urge
its passage.
Thank you.
[The prepared statement of Mr. Leggette may be found at end
of hearing.]
Mrs. Cubin. Thank you, Mr. Leggette.
Mr. Hawk?
STATEMENT OF PHILIP J. HAWK, PRESIDENT & CEO OF EOTT ENERGY
CORP.
Mr. Hawk. Madam Chair, good afternoon.
My name is Phil Hawk, and I am the president and chief
executive officer of EOTT Energy. As a context for my remarks
today, I would like to briefly describe our business. EOTT
Energy is one of the largest independent gatherers and
marketers of crude oil in North America. We are the guys you
have been talking about that seek to get that uplift from the
wellhead to the ultimate users of crude oil refiners.
We purchase over 300,000 barrels a day at the lease. By the
word ``independent,'' I mean we do not have any economic
interest or ownership in any of the producers or their
production or in the refineries that we ultimately sell to. We
make a profit by providing the services necessary to officially
and effectively move crude oil from a site of production to its
ultimate user.
Our services include a broad range of logistical,
administrative and marketing activities. For example, we own
and operate over 2,200 miles of pipeline, 6 million barrels of
storage and operate over 275 tank trucks. We maintain extensive
division order and royalty records and make disbursement of
production proceeds on behalf of producers to over 150,000
interest owners. In total, we have over $150 million in assets
as well as over 900 people providing these services.
As a return on this substantial investment in assets and
resources, we strive to earn a small margin which we hope is
commensurate with our value provided. On average over time, we
strive to earn approximately 15 cents per barrel. However, as
it is for all competitive industries like ours, there is no
guarantee of profit. Due to the difficult market conditions and
intense competition in 1997, our company failed to make any
profit at all. Contrary to the inferences of some, competition
to purchase crude oil at the lease is broad based and intense.
Now, from this perspective as a major purchaser, gatherer
and marketer of crude oil, we strongly support the Royalty
Enhancement Act of 1998 and the RIK program and associated QMA
program. We do so for three primary reasons. First, RIK is the
best way to achieve market value for the government's
production.
The market value of a specific barrel of oil is affected by
a large number of factors: quality or refining value, the
transportation or logistics expense necessary to move that to
market, the relative access to various markets, different
refineries that may value that barrel differently, the
shortages or surpluses of that particular type of crude oil or
its alternatives that may exist in a particular market at a
particular point in time, the length of purchase or sales
commitments by either the producer on the purchase side or the
sales side and the refiner on the purchase side, and also the
ability to leverage intermediary activities of a company such
as EOTT which could provide additional aggregation
opportunities or cost sharing that not otherwise would be
available to an individual producer.
To show how these various factors come into play in the
market, I wanted to share with you in my testimony the actual
prices, market prices, paid for seven apparently similar leases
at the same point in time in the state of Wyoming. These leases
were all purchased from unaffiliated third parties and we won
the right to purchase that on a competitive bid basis, so these
are in my view market prices.
Due to all of the factors I mentioned above, the price
ranges for these--this is for the month of December--range from
a low of $10.78 to a high of $12.31, or a differential of
approximately $1.50 per barrel. Let me assure you that the low
prices listed here do not represent windfalls to EOTT, but
rather they reflect the numerous and complex considerations
that go into the determination of market value.
I contend that there is no formula that could accurately
calculate or estimate these real differences in value.
Consequently, the only approach to determine and ultimately
receive market value is to sell the oil on an open and
competitive basis. That is the essence of what the RIK program
along with the use of qualified marketing agents allows and
provides to the government. Any other approach, in our view,
will create doubt as to whether or not the government is
receiving full value. There are several other benefits as well
that several of the other people have testified to.
The RIK program creates certainty and lowers administrative
costs. The prospects of audits and second-guessing after the
fact is time consuming and expensive at its best, but I would
suggest that the uncertainty associated with the potential
audits and possible retroactive price adjustments in the final
analysis reduces the attractiveness of MMS leases and reduces
the ultimate proceeds that return to the government. From a
government perspective, the need for audits would be greatly
reduced and therefore the administration of this program should
be greatly simpler than current approaches.
Finally, the RIK program enables the government to market
crude oil at its most attractive sales point. It has the option
to sell crude oil at the lease or anywhere downstream where it
is most attractive.
Now, I will tell you as a service provider in this
industry, in an industry that I believe is pretty competitive,
that we believe that aggregators like EOTT generally move crude
oil downstream more efficiently and effectively than individual
producers. I think the evidence of that is that we are a
significant purchaser of that crude when, again, private
producers have that option and right today to move it to market
themselves.
Nevertheless, the RIK program does not arbitrarily
determine that the point of sale must be the production point.
It gives the latitude to the government to sell it at the most
attractive point of sale, whether that be at the point of
production or at any point downstream.
In summary, we strongly support the RIK program because it
provides the best and most direct opportunity to ensure that
the government receives fair value; it greatly simplifies and
adds certainty to the royalty valuation issues that have
hampered this industry and should greatly simplify the
administrative costs in managing it; and by virtue of the
flexibility it provides, it gives the opportunity to the
government to sell its crude oil at the optimum location,
wherever that might be.
We might also point out that to be effective the RIK
program needs to be broadly implemented and maintained over
time. This is not a spot program that can be chosen or not
chosen on a month-to-month or year-to-year basis, but needs to
be the basic marketing approach for the government's royalty
barrels.
Finally, the proposed program will enable the government to
utilize the substantial marketing expertise that already exists
in the industry via the QMA approach to realize the full value
for its crude oil.
Thank you very much.
[The prepared statement of Mr. Hawk may be found at end of
hearing.]
Mrs. Cubin. Thank you very much for your testimony. I have
two very simple, straightforward questions. I think I will ask
the first one of Mr. Leggette. Why mandatory RIK?
Mr. Leggette. Right now, there are at least two significant
impediments under existing law to the Department's achieving
the kinds of benefits that it could under this bill. One is
that the government does not have a universal right to require
that its royalty be paid in kind. There are so-called Section 6
leases off the Coast of Texas and Louisiana where that option
is with the lessee. Elsewhere the government does have the
right, but there is a significant additional obstacle.
It is reasonably clear that under the OCS Lands Act the
price at which the government would have to sell the oil would
be a price determined by an averaging of prices received at the
lease in the field. By definition, that precludes any
possibility of getting the uplift from moving oil or gas
downstream to hubs or marketing centers. Offhand, I am not sure
if there is a similar impediment with onshore leasing, but
there probably is at least some doubt about where the
government could sell the oil that it took in kind. In the
illustration I gave in my testimony, the royalty in kind was
sold at the lease.
Mrs. Cubin. Thank you. I just wanted to say that I did not
think the chart looked like Dungeons and Dragons. It looked
more like the 1994 or 1995 Clinton nationalized health care
plan is what it looked like to me.
[Laughter.]
Mrs. Cubin. My second question--and this is of you, Mr.
Schaefer--why in Director Quarterman's testimony she said that
it was not realistic or would not be cost-effective to have
royalty in kind on marginal wells. Why should the United States
have to take its royalty in kind from marginal wells?
Mr. Schaefer. Well, I believe that there is an advantage to
be gained by taking them from marginal wells because the
government can aggregate all the oil from the marginal wells
and put them into one pool or pocket and actually optimize the
return by pooling and putting it in, whereas for the individual
who is operating a marginal well that is not as attractive on
the market, those volumes. If they can be aggregated somewhere,
it is going to be more attractive and should bring a higher
price.
Mrs. Cubin. That is exactly what I thought, but it seemed
like such a simple concept I thought, ``Well, I must be
mistaken here.'' It seems to me that royalty in value would
exponentially be less cost effective for those marginal wells
than royalty in kind would be.
Mr. Schaefer. Well, I think it would be less cost effective
to the government and to the lessee because whether it is a
marginal well or a nonmarginal well, you still file the same
reports and you go through the same paperwork and you may be
faced with the same kind of audit problems that you would with
a highly prolific well.
Mrs. Cubin. Right.
Mr. Schaefer. There is no difference there.
Mrs. Cubin. Thank you very much.
Mr. Thornberry?
Mr. Thornberry. Thank you, Madam Chairman.
That was exactly one of the lines of questioning that I
wanted to ask of these witnesses. It seems to me to be a key
objection to MMS that if you make it mandatory it applies to
marginal wells out in the middle of nowhere and there is no way
you can do that to make money. I think you have answered that
very well.
Do either of the other of you have a comment on that point
about marginal wells, whether it would be profitable, whether
it could be profitable to take that royalty in kind rather than
in value?
Mr. Leggette. I am not an economist, but I play one on TV.
I will just add briefly that I agree with Mr. Schaefer's point,
because what makes marginal properties so unattractive for a
buyer buying ad hoc is the transactional costs of going out and
picking up a lot of individual packets of oil. But if the
government can get a market person in there to aggregate that
oil, which is exactly the function Mr. Hawk's company plays,
that is where they make the money.
Mr. Thornberry. Indeed, not only is it possible RIK would
not reduce the money coming into the Federal Government, it
could actually be substantially more than in value because you
do have the ability to aggregate even the production for
marginal wells. It is worth more that way rather than a few
barrels at a time.
Mr. Leggette. The proof is the success of Mr. Hawk's
company.
Mr. Thornberry. Mr. Hawk, let me ask you--I hope you were
here for a little bit of the discussion I had on what methods a
QMA may want to use to bid to be able to sell oil or gas. Can
you describe for me some possibilities at least that you might
envision how this might work? Is it completely beyond the realm
of the possible, for example, that somebody might bid to market
the Federal share just to have that bigger volume and to have a
more valuable asset to sell?
Mr. Hawk. I think just stated simply as you described it, I
am not sure I can answer the question. I do not know because,
obviously, there would need to be an uplift opportunity
available to the QMA in your scenario. I think there are many
ways the marketing industry can participate and assist the
government.
I would encourage the Department of Interior in setting up
the rules or exploring this to challenge the industry to
propose those, and as part of their proposals come forward
competitively with the various approaches that would work. They
could include a small marketing fee, in terms of just
administratively handling, acting as an agent on behalf of the
government; they could be incentive-based fees based on the
achievement of results on an absolute basis or relative to
relative indexes that would be mutually agreeable to the
government and the marketing agent. There could be just a whole
range of factors.
I would say this that one of the things as we contemplate
the possibility of being a QMA, if this should come to pass--
and we are, by the way, participating, at least offering
counsel and guidance to the MMS in their Wyoming pilot in terms
of as they work that through--is that what we want to avoid is
a situation where we inadvertently shift this tremendous audit
burden which is now on the producer that all we do is shift it
one step downstream and through complex relationships create a
huge audit requirement just one step removed.
I think the arrangement needs to be simple and
straightforward where it is very clear to all parties--
obviously there needs to be audits on volumes and things of
that sort, but it needs to be simple and straightforward where
there is not a need for any extensive audits of any of the
parties on this.
Mr. Thornberry. OK. Can you briefly--these are some
fundamental terms in this discussion and I am not sure that
they have been explained adequately--could you briefly describe
``uplift'' and ``aggregation,'' and how it is that the Federal
Government could actually receive more money for the same
quantity of oil because of these factors?
Mr. Hawk. The term ``uplift'' refers to the difference in
the sales price at the wellhead and downstream locations. The
highest point of uplift would probably be a sale of WTI on the
New York Mercantile Exchange. The differential can be several
dollars in some cases, particularly with sour grades or
different qualities. More than $5 in some instances with the
sour grades that you were mentioning.
The uplift, so that is the differential. The premise is,
``Well, gee, wouldn't it be better to sell it for a NYMEX price
than the price I am receiving at the wellhead.'' This is most
certainly true if you do not need to spend the resources, take
the risk and absorb the cost associated with moving it from
that point to that higher sales point.
Mr. Thornberry. No, that is helpful.
Mr. Hawk. What ``uplift'' means is basically the moving of
the product downstream to sell it at a higher value location.
Mr. Thornberry. In summary, what we are talking about is
having somebody in the business try to sort through cost and
bene-
fits and figure out where along that continuum is the best
place to sell it.
Mr. Hawk. ``Aggregation'' is the bringing together of
smaller pockets of MMS oil into a bigger pool. As a company,
our industry is an aggregator. The reason that is valuable is
there are significant fixed costs in this business. As we can
spread that over higher and higher volumes, the unit cost of
managing or administering the various aspects of our services
decline. The basic benefit of aggregation is to spread fixed
cost over more barrels.
Mr. Thornberry. Thank you.
Mrs. Cubin. Mr. Tauzin?
Mr. Tauzin. Mr. Leggette, in your magical history tour you
took us, I think, to the 1950 decision, Continental Oil v.
United States or the United States v. Continental Oil? Is that
the one?
Mr. Leggette. Yes.
Mr. Tauzin. I am reading from it, and what I read in it is
literally a conclusion by the Ninth Circuit, and I quote:
``The contract provision authorizing one party to the
contract to fix the obligation of the other party by
unilateral action is so foreign to ordinary contracts
and so drastic in operation we think it should not be
implied in the manner for which the government is here
contending. We think that such a right cannot have been
within the contemplation of the parties in the absence
of expressed reservation to that effect.''
That goes back to an old Latin judicial rule, ``Expressio
unius est exclusio alterius,'' which I think means, you know,
unless you have an express provision you cannot apply it in a
contract. What I read from this decision is quite contrary to
what I heard from Ms. Quarterman. What I read is that
government cannot fix a value of royalty payment on a
downstream location and assess the cost of transportation and
marketing to the lessee, in effect. In other words,
interpreting the contract in order to have the best of both
worlds, as I was trying to illustrate when Ms. Quarterman was
in her statement, which is what she wanted to do.
Am I correct that this court decision flies in the face of
that government position that it has the right to interpret the
contracts so as to impose the cost of transportation and
marketing on the lessee and then take the added value at some
point downstream without having had to share in the risk? Is
that what this court says?
Mr. Leggette. That is correct. The court is saying that
unless the lessee has expressly agreed to give the secretary
that power, he lacks the power through implication to make the
rules up as he goes.
Mr. Tauzin. In short, if the contract does not clearly
provide that interpretation to the secretary, the Department
cannot interpret it that way? To do so would be to allow the
bureaucracy to constantly reinterpret contracts to the best
advantage of only one of the parties without the express
consent of both parties in the contract to that arrangement?
Therefore, does it not follow, then, that we need to do one
of two things, either we have to have contracts that expressly
define the sharing of that cost and the accounting procedure
accordingly, or we in Congress have to pass a law that clearly
defines the rights of the government in terms of its oil and
gas royalties as an RIK program bill would do?
The worst alternative is to leave it to bureaucrats to
write a complex system by which they can constantly and
subjectively make determinations of value that were never
expressly accorded to the Department as a party to the
contract. The Ninth Circuit is saying not only is that bad
policy, that is illegal.
Mr. Leggette. That is correct. I agree with you fully. Door
No. 3 is a snake pit.
Mr. Tauzin. Yes, that is right. The Dungeons and Dragons
analogy is accurate. I mean, I see lots of snake pits. I mean,
I have tried to follow this, the copy of the chart I was
looking at. It literally, again, leaves the Department time
after time in every one of these yellow locations the ability
to turn into a dragon and make its own decision about what the
contract means. I do not think that is in the interest of good
Federal policy to encourage companies to come in and bid on
leases and produce minerals here in America.
After all, I mean, I know a little bit about this business.
I was in the state government and chaired the Natural Resource
Committee in Louisiana that oversaw oil and gas activities in
our own state as well as a whole wide range of other issues. I
know for a fact that all of the companies who operated in our
state and in our OCS they had some choices to make. They could
either produce there or they can go elsewhere in the world and
put their dollars into exploration and development and
production.
If our government continues to play this game of
reinterpreting contracts to best suit the interest of
collecting more money from the lessee whether or not the
contract gave them that authority, I suspect we are going to
continue to drive companies to go produce somewhere else and
import it into this country rather than producing it in our own
land and providing it for us in this country.
It seems to me that if I read this court decision
correctly, Ms. Quarterman's contention that the government has
the right to literally take all of the value at no risk and
force the lessee to take all the risk in any circumstance where
the government chooses to do so is not only contrary to this
legal precedent, but I think contrary to good national policy
if we are going to have a good partnership relationship between
those who come in and bid these leases--we had another great
successful lease in Louisiana just yesterday--if we are going
to continue to have successful lease auctions and successful
exploration and development programs in our own country. I want
to again commend the author for this attempt to put some sanity
in this process.
I am on the road with Dick Armey in a wonderful tour we
call Scrap the Code tour. The reason I have joined that tour
and given so much of my time and attention to this national
debate is that we now have a 5.5-million-word tax code that is
so complex the government does not know what it means anymore.
It gave out 8.5 million wrong answers to taxpayers one year
alone and then fines and goes after taxpayers who have relied
upon that misinformation. I see it happening all over again
here.
I see it, Mr. Schaefer, in the descriptions of the cases
you have given us where relying upon information you thought
was right you end up years later being brought into court and
like some criminal hauled before the Bar to answer for some new
evaluation technique invented by another department using their
own judgment about what a contract means.
I think the Ninth Circuit Court said it best. The
government has no right to interpret unilaterally at the
expense of the other party. We are going to have very many
changes in the way in which we contract these things, or we
have to write some new law. We cannot, in my opinion, leave the
Department the power to continue to create messes like this for
us.
Thank you very much.
Mrs. Cubin. I thank the panel for their testimony and the
committee for the witnesses.
Are there any further questions?
Mr. Thornberry, did you have any?
Mr. Thornberry. Madam Chairman, I would just ask permission
to have a couple of documents included in the record at this
point, one from the Domestic Petroleum Council and another from
API, Mid-Continent, the National Ocean Industries Association,
and Rocky Mountain Oil and Gas Association.
[The information of Mr. Thornberry may be found at end of
hearing.]
Mrs. Cubin. Without objection. The hearing record will be
held open until the next hearing, which will be on the 31st,
and then after that it will be held open for two weeks so
anyone who wants to supplement their testimony or whatever, ask
questions is welcome to do that.
Thank you very much. The Subcommittee stands adjourned.
[Whereupon, at 4:30 p.m., the Subcommittee was adjourned.]
[Additional material submitted for the record follows.]
Statement of Hon. Jim Geringer, Governor, State of Wyoming
Madam Chairman, members of the Subcommittee, thank you for
your invitation to address H.R. 3334, the Royalty Enhancement
Act of 1998, sponsored by Representative Thornberry and
cosponsored by yourself and Representative Brady. I commend you
for your efforts to work with individuals, associations and
state governments concerned with this issue. We need
alternatives to the present Federal oil and gas royalty
program.
I am here today in my primary role as Governor of Wyoming,
but I also speak as Chairman of the Interstate Oil and Gas
Compact Commission and as Vice-Chairman of the Western
Governors' Association.
Madam Chairman, I speak in favor of H.R. 3334. The
legislation would allow Federal royalty oil and gas to be taken
in-kind by the United States rather than in cash, and allow
states at their discretion, to do the same for their legal
share.
H.R. 3334 would:
<bullet> simplify the royalty collection process
<bullet> decrease administrative costs for both the Minerals
Management Service and industry, thereby increasing the net
payment to the state
<bullet> provide certainty in royalty valuation
<bullet> decrease the costs of audits and subsequent appeals,
and
<bullet> achieve a fair and equitable market value for the
products.
Wyoming has long been frustrated with the lack of a simple and fair
method to value oil and gas for royalty payments. Some producers and
lease holders work hard to be objective and above-board to value the
product. Others are not as forthcoming, and instead devise all sorts of
marketing transactions to camouflage the real market.
Wyoming's interest in a royalty in-kind program for Federal oil and
gas royalties is based on experience and frustration with the current
Federal royalty program. Under the current system the states receive
their 50 percent of Federal mineral royalties on a ``net receipts
sharing'' basis, which means that the states suffer a deduction of up
to 25 percent of the costs of administration of the minerals program.
We don't like the high cost of Federal administration. In the fall
of 1996, I proposed to Assistant Secretary of the Interior, Bob
Armstrong, that Wyoming be allowed to take its royalty share in-kind
rather than pay the multimillion dollar cost of Federal collection and
administration. We are convinced that Federal charges are as much as
seven times higher than what the states would spend for exactly the
same program under state administration.
The Federal Government could receive the same or greater income
from Federal in kind royalties as it would receive from traditional
royalty payments. That would in turn, benefit the states. A royalty in-
kind program could easily have lower administrative costs than the
current royalty valuation program. States would then benefit because
the Mineral Management Service royalty management costs are currently
deducted from total royalty collections before the states ever receive
their share.
Wyoming has never been able to obtain a full accounting for the
Federal deductions. In 1993 the State completed a study of the
projected cost of administration of a state operated royalty
administration program. The conclusion of that study demonstrated that
a state program meeting all basic Federal requirements could be
operated at a significant cost savings to both state and Federal
royalty owners. However, lack of detailed disclosure of cost breakdowns
for the Federal MMS program would not allow a direct comparison.
The General Accounting Office, in 1996, conducted a study
attempting to compare the costs of collecting Federal mineral royalties
by MMS and the cost of collecting state royalties by various state
offices. The conclusion of the GAO study was that it was impossible to
compare both programs because their tasks were so different. We
disagree with that conclusion. The tasks of monitoring leases,
production, valuation and collection of royalties are no different
whether on a state lease or a Federal lease. The difference this study
did not seem to want to address, is the overly large bureaucracy
inherent in the Federal systems to monitor, value and collect the
royalties.
More recently, in October 1997, the Department of Interior's
Inspector General's office issued an audit report of the Minerals
Management Service, Bureau of Land Management and USDA Forest Service.
It analyzed the expenses charged against Federal royalties in the
context of net receipts sharing for fiscal years 1994 through 1996. The
conclusion of that report was that the states have been overcharged.
New Mexico and Wyoming have since asked the Secretary of the Interior
to refund the overcharges.
I understand that the members of the Subcommittee are familiar with
the current effort by MMS to develop new methodologies for valuation of
royalty oil. Wyoming has given only qualified support for this effort
as recognition of the difficulties in valuation caused by non-arms-
length transactions between affiliates. We remain concerned that the
proposed method of valuation based NYMEX pricing does not sufficiently
relate to the realities of the regionalized Wyoming marketplace. MMS
might be able to justify the NYMEX approach since regional differences
tend to come out neutral overall for the Federal share. Not so for
regional markets including Wyoming. MMS did attempt to incorporate our
comments in the proposed rule to recognize a Rocky Mountain Region
market. We don't care for NYMEX pricing as it is a futures market. The
Wyoming proposal would create at least two other benchmarks for any
non-arms-length transaction before resorting to NYMEX. The tendering
benchmark, at 33 1/3 percent of Federal and non-Federal leases in the
area, will be difficult meet. We thought that a 15 to 20 percent
benchmark would have been more realistic. The second benchmark would be
established by comparable sales in arms-length transactions. Again,
here, the benchmark is too high to be of much use. The rule will
require that 50 percent of sales be arms-length in order to be used as
benchmarks. The state believes that 20 to 25 percent would have been a
sufficient statistical percentage to establish the value of oil in a
particular area. We are not confident that a single national valuation
approach can be devised which could apply to regional markets.
Wyoming's interest in a royalty in-kind approach precedes this MMS
valuation initiative, and we believe that the difficulties under the
MMS approach will provide even more impetus to go to a royalty in-kind
process.
While each of these experiences has caused Wyoming to call for a
re-engineering of the Federal royalty program, we are equally motivated
by the opportunities for revenue enhancement under royalty in-kind. We
expect major cost reductions under a program that would no longer need
a system for collection, analysis and auditing of pricing data. More
importantly, we believe that the marketplace holds significant promise
for increased state revenues.
The State of Wyoming is prepared to assume the responsibility for
our share of Federal royalty oil and gas. The 1997 Wyoming Legislature
authorized the state to take its share of Federal mineral royalties in-
kind under Wyoming Statutes 9-4-601(g). The production would be taken
in the same percentage of volume as the gross percentage of royalty
proceeds.
I further note the strong support of many states other than
Wyoming. The Interstate Oil and Gas Compact Commission, representing
America's oil and gas producing states, has monitored important
developments in energy regulation for over sixty years. The 36 member
states have worked cooperatively since 1935 to address energy
conservation and borrow from each others' experiences to come up with
solutions to our common problems. During the 1997 Annual Meeting, the
members of the IOGCC unanimously approved a resolution to support the
development of a comprehensive and flexible Federal royalty in kind
program for oil and gas. The resolution also supports allowing a
producing state, at its sole option, to assume those marketing and
administrative functions designated to the designated to the Federal
Government which your legislation would also allow.
Proper design and implementation is critical to the success of a
Federal royalty in-kind program. The program must reflect the concerns
and ideas of the states, producers, marketers and the MMS. Your
legislation would allow that. As you move the legislation, I urge you
to ensure that the legislation maintains:
<bullet> the requirement that royalty in-kind will be allowed
by the Federal Government
<bullet> the requirement that the Federal Government contract
with a qualified marketing agent
<bullet> the option for states to elect to contract with the
qualified marketing agent on behalf of themselves or the
Federal Government
<bullet> the intent to keep audit requirements simple and non-
duplicative, and
<bullet> the goal to reduce government costs and increase
returns to the Federal and state treasuries.
I ask that as the process progresses, you allow us to continue to
work with you in refining the bill's language. The bill draft was not
available to us until lately, Madam Chairman, which as you know is a
very hectic time with the State Legislature in session. We will
continue to analyze H.R. 3334 and will alert you to any concerns we
might have.
Again, I thank you for your courtesies and the invitation to
testify. I would answer any questions you might have.
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Statement of Cynthia L. Quarterman, Director, Minerals Management
Service, U.S. Department of the Interior
Madam Chairman and Members of the Subcommittee, I
appreciate the opportunity to appear today to present testimony
on H.R. 3334, and on the Minerals Management Service's (MMS)
implementation of programs to take oil and gas royalties ``in
kind.'' In testimony submitted for the July 31, 1997 and
September 18, 1997 hearings on royalty in kind (RIK) before the
Subcommittee, we provided background information, described the
results of our 1997 Royalty in Kind Feasibility Study, and
summarized our plans to implement three RIK pilot projects. My
testimony today will briefly address RIK legislative
initiatives before providing a progress report on our three
pilot projects.
RIK Legislation. At the outset, I would like to make the
Department's position on RIK legislation perfectly clear.
Legislation is not needed to exercise our lease contract rights
to take royalties in kind. The Mineral Leasing Act, the OCS
Lands Act and the lease agreements with the producers all grant
the Federal Government the option to take our royalties in
kind. The Department, therefore, strongly opposes any
legislation mandating the United States to take its mineral
royalties in kind and would recommend that H.R. 3334 be vetoed
if it were presented to the President.
I would also like to clarify our position on RIK
implementation. As I testified last year before this
Subcommittee, we are excited by the potential of RIK programs
to streamline and improve aspects of our royalty collection and
verification processes. RIK programs might increase revenues to
the Federal Government, but only if implemented under favorable
conditions. Accordingly, we are aggressively working on an
ambitious schedule to implement three major RIK pilot projects.
The results of these pilots will allow us to select areas where
RIK can provide additional net revenues, and avoid those areas
that will lose revenues.
There is no inconsistency in these positions. We strongly
believe that both the Federal Government and industry need to
conduct realistic tests of the RIK concept under actual
conditions prior to any administrative or legislative decisions
on broader implementation. RIK is unproven and risky for
royalty collection in the U.S. As stewards of public assets, we
must have assurance that the revenue and administrative effects
of RIK are decidedly positive before moving to implementation.
Anything less is a gambler's folly with the taxpayers money. We
must identify and test those factors that would lead to RIK
program success and then structure any broad programs around
those factors. A legislatively-mandated RIK program would
unnecessarily limit the flexibility of lessees and the lessor
in the optimal design and implementation of RIK and destroy the
value of being able to choose which collection method, ``in-
kind'' or ``in-value,'' works best in each location.
H.R. 3334. I will limit my discussion of the bill that is
the subject of this hearing to only a few general reactions
because we have not prepared a detailed analysis. First, we are
frankly disappointed that this bill is weighted heavily in
favor of the oil and gas industry. Simply put, the bill would
force the United States to relinquish many of its long
established legal rights as lessor while relieving lessees of
many of their equally long established legal obligations. The
collective result of the bill is to drastically reduce the
options and legal rights of the Federal mineral lessor. We must
seriously ask ourselves how it is to the advantage of the
citizens of the United States to give up these rights, and as a
result, give up a substantial part of the value they receive
for the production of their non-renewable resources.
There are many specific components of this bill that would
act to decrease the value of Federal mineral royalties.
Although these details would have substantial revenue and legal
implications, they are too numerous to discuss adequately in
this testimony. We will provide a list and description of
effects of these items under separate cover. For today's
purposes, the most important point we wish to make is that,
notwithstanding the details of the bill, there are several
overarching reasons why this legislation is misguided and
detrimental to the public.
<bullet> First, the Federal lessor would assume costs of
marketing oil and gas in an RIK program where production under
U.S. title is sold downstream of the lease. Under the
historical ``in value'' royalty scheme currently in effect, the
Federal Government has not shared such costs. Thus, royalty
revenues to the Federal Treasury will logically and
unambiguously decline under RIK.
A major purpose of our RlK pilot programs is to identify and
test the circumstances under which Federal in kind production
could be made more valuable in the marketplace. Our 1995 Gas
Marketing Pilot demonstrated the potential for RIK to lose
money. Our 1997 Feasibility Study suggested that revenue
``uplift'' is most likely for Gulf of Mexico gas, and unlikely
for oil. No one, how-
ever, knows and actual tests are necessary for both oil and
gas, to better understand the real potential for enhanced
value.
<bullet> Second, our 1997 RIK Feasibility Study and subsequent
analyses have identified several unfavorable conditions under
which RIK programs would reduce revenues. These conditions
include taking de minimis volumes in remote areas, taking
production at less than marketable condition, and paying above
market rates for transportation. H.R. 3334 would mandate RIK
programs in areas where these unfavorable conditions exist,
ensuring a loss of revenue from these areas.
Our RIK pilot programs will be structured to isolate and test
the effects of various factors affecting RIK program success,
thus reducing the exposure of Federal revenues to loss and
providing the information needed to intelligently choose where
to implement RIK.
<bullet> Third, the Bill would statutorily adopt many of the
positions taken by the oil and gas industry in historic
valuation disputes with the Department--disputes, I might add,
that have been consistently won by the Department. This would
be an unjustified major economic gift to the lessee.
Specifically, the Bill would require the United States to begin
paying for: (1) gathering of production before it reaches the
royalty meter; (2) movement of unseparated, bulk production;
(3) field treatment of production; and (4) would absolve the
lessee from the duty to market. Further, the bill's prescribed
methods for setting rates for upstream transportation would
significantly increase these rates, which the Federal
Government would be forced to pay.
<bullet> Fourth, the bill's criteria under which government
marketing agents could sell to themselves or affiliates are so
broad and unenforceable that they would assure continuation of
disputes between marketers and the U.S. over sales prices and
substantial administrative costs for both the government and
marketers.
<bullet> Finally, we believe the bill is riddled with other
provisions that make it unacceptable.
We must be careful not to enact legislation that serve only the
special interests of either lessee or lessor. For the reasons I have
described, we can only conclude that this legislative initiative is
primarily designed to enhance the interests of oil and gas producers,
at the expense of the American taxpayer.
Model RIK Programs. In its support of mandatory RIK, the oil and
gas industry has pointed to the RIK programs of Texas and Alberta as
models of successful RIK program. Yet, many of the major elements of
these programs are not included in this legislation. It is these key
``missing'' elements that are, in fact, directly responsible for the
success of the Texas and Alberta programs. Specifically:
<bullet> Alberta: According to Alberta officials, the
Province's agent has the authority to take imbalance shortages
at times of high prices. Further, lessees are required to
deliver Crown production to pipeline interconnects, at
significant distances from the lease, at non-discriminatory
rates. The marketing agents' 5 cents per barrel marketing fee
is modest because much of the work to aggregate Crown
production is performed by the lessee. Domestic producers have
told us that U.S. marketing fees could be at least 15 cents per
barrel. Without these and other advantages, Alberta's marginal
5 cents per barrel revenue gain from RIK would quickly become a
big loss.
<bullet> Texas: We understand that the State's oil RIK program
has in recent years gone from decidedly revenue positive to
essentially revenue neutral, as producers began paying
royalties for non-RIK State production at market value. In
addition, the State's oil RIK program is not mandatory, and it
does not include production from wells that produce less than
10 barrels per day or from any particular lease that the state
chooses to exclude from the program. The inclusion of such tiny
volumes would likely cause the State program to lose revenue.
With respect to Texas' RIK program for natural gas, the State
directs the producer to deliver royalty volumes to convenient
sales points, free of any charges. Further, State law requires
pipelines in the State to transport Texas royalty volumes if
nominated, at non-discriminatory rates. These are big
advantages that essentially assure success. If we truly want a
successful RIK program for the U.S., why don't we see these key
elements in this legislation?
Relationship to Valuation Regulations. We at MMS regard our program
initiatives in valuation regulations and in-kind royalties as
completely independent efforts. However, it has become apparent that
the oil and gas industry views these efforts as directly related.
Specifically, we are told by industry representatives that mandatory,
across-the-board RIK is needed because MMS valuation policies and
regulations are abandoning gross proceeds as a valuation basis. To such
assertions, I respond as follows:
<bullet> Our recently-published supplemental proposed rule for
crude oil valuation contains five valuation principles,
including that royalty obligations for arm's length contracts
should be based on gross proceeds received under such
contracts.
<bullet> Under our supplemental proposed rule, some 68 percent
of Rocky Mountain crude oil production would be valued for
royalty purposes based on gross proceeds received under arm's-
length sales.
<bullet> In a close-out audit meeting, the General Accounting
Office recently told us that it found MMS has been responsive
to industry concerns expressed in public notice and comment on
the crude oil rule, and that it did not advise statutorily-
mandatory RIK programs.
<bullet> For the record, I wish to clarify the lease
requirement that a lessee has the duty to market at no cost to
the lessor, since it has so often been misrepresented. It does
not mean that we will second guess a lessee's decision not to
market at downstream locations. MMS has never done such second
guessing and has no plans to do so in the future. MMS does not
participate in the marketing decisions of the lessee, does not
tell the lessee how to market its product, and accordingly does
not participate in its cost.
Royalty in Kind Pilot Projects. As you are aware, last summer, our
senior management team at MMS accepted the recommendations of the 1997
RIK Feasibility Study, namely to implement RIK pilot projects in
Wyoming (crude oil in-kind), offshore Texas in 8(9) waters (natural gas
in-kind), and the Gulf of Mexico (natural gas in-kind). I am pleased to
report to you that we are currently making great progress in
implementing these recommendations. We have formed an RIK team of some
16 staff dedicated to successfully implementing these projects.
<bullet> Wyoming Crude Oil Pilot: We are on course to begin
this 2- to 3- year pilot program in October of this year. The
objective of the Wyoming Pilot is to test the administrative
and economic feasibility of a variety of methods and conditions
of RIK programs for onshore crude oil--in a manner that at
least preserves revenue neutrality. From the outset, we have
been developing the pilot in close partnership with the State
of Wyoming.
We will test the effects of such factors as sales methods,
production volumes and qualities, transportation methods, and
lease location. We recently held a well attended public meeting
in Casper where the RIK team obtained useful input on these and
other factors, primarily from the industry and State
governments. The pilot is currently on track for its October 1,
1998 start date.
We have been enjoying a close and cooperative working relationship
with personnel from the State of Wyoming. I understand that the State
is considering whether to commit State lease royalty volumes to the
joint RIK Pilot. We understand it will decide after an early April
briefing on the detailed final structure of the Pilot. Governor
Geringer and I will receive the same decision briefing from the RIK
implementation team. Our interests in the pilot are the same--to
produce the best possible test of the RIK concept and the knowledge
confidently use it to assure full and fair market value for our
resources.
<bullet> Texas 8(9) Pilot Project. We are working with the
State of Texas concerning implementation of a natural gas Pilot
project for offshore 8(9) leases in the Gulf of Mexico. As you
know, the State has an existing successful RIK program from
State leases. While Texas enjoys significant advantages in its
RIK program, that we will not have, the General Land Office has
considerable experience and expertise that will help us design
the best possible pilot. We are exploring the potential for a
joint program that could potentially supply the State, other
end users in Texas, and Federal facilities. By supplying the
needs of Federal Facilities with RIK gas, we might not only
increase royalty revenue but also reduce energy costs for the
Federal Government. We also expect this pilot to begin October
1, 1998.
<bullet> Outer Continental Shelf RIK Project. This project is a
logical follow-on to our 1995 gas RIK pilot, and will involve
substantial volumes of OCS natural gas handled by one or
several marketing agents. Similar to the Wyoming Pilot, the OCS
project will test a variety of factors, including the method of
marketing.
The size and complexity of this project dictate that it will
take another year before we can begin with confidence. The
start-up date is anticipated to be October, 1999. Currently, we
are assessing lease data, pipeline infrastructures, procurement
options, and marketing strategies. The project structure will
be presented in the Fall of this year. We anticipate convening
a series of public meetings to collect comments, have open
discussions about our planning, and further refine our pilot.
We invite the industry and all interested entities to work with
us.
I wish to emphasize that the pilot projects described above form a
logical, deliberate process designed to test the feasibility of RIK
programs across a broad swath of Federal lease and production
situations. We strongly believe that implementation of RIK across-the-
board, without discovering its real impacts in actual programs, is
unwise and risky. The royalty revenues from Federal leases are too
important to the American taxpayer and mineral producing States to risk
blindly jumping into mandatory RIK before we know how and if it will
work.
Some have speculated that we oppose legislation mandating RIK
because of a fear of losing jobs. We highly value the contributions of
our employees, and will continue to do so under any type of royalty
scheme that may evolve from the current one. We at MMS believe that we
have a very effective royalty management program, which last year cost
taxpayers only a penny for each dollar collected. Nevertheless, we are
always striving to improve our royalty management systems to increase
efficiency and effectiveness. Our current reengineering effort in the
royalty management program promises to provide efficiencies to increase
our productivity for the taxpayer. Even with mandatory RIK many of our
functions and costs would remain. Our opposition to this legislation
begins and ends with the fundamental principle of ensuring that the
public receives fair market value for its assets.
In closing, let me state that we are enthusiastic about the
prospects of implementing successful RIK programs for Federal mineral
leases. Such programs may provide an innovative way to streamline the
royalty management process. Effective implementation of the already
existing RIK option, developed through the practical and prudent
investigation of our pilot programs, spells success not only for
royalty management but for the taxpayer as well.
We will need some time to fully assess the revenue implications of
this bill. However, it clearly represents a dramatic transfer of costs
and obligations from the oil and gas industry to the American taxpayer.
Our preliminary analysis suggests that the revenue loss would be
significant and on the order of hundreds of millions of dollars at a
minimum. I believe we must seriously ask ourselves how the American
taxpayer would benefit from H.R. 3334. Because of the disastrous effect
this bill would have on the taxpayer and the budget, the Department is
prepared to recommend a veto.
Thank you Madam Chairman and Members of the Subcommittee, this
concludes my prepared remarks. I would be pleased to answer any
questions you may have.
______
Statement of Hugh V. Schaefer, Director, Welborn Sullivan Meck &
Tooley, P.C., Attorneys at Law, Denver, Colorado
Ladies and Gentlemen:
My name is Hugh Schaefer. I am chair of the Royalties Committee of
the Independent Petroleum Association of Mountain States (``IPAMS'').
IPAMS is a non-profit, non-partisan association representing over 700
independent oil and gas producers, service/supply companies and
industry consultants in the Rocky Mountain region. IPAMS appreciates
the opportunity to appear before you today and present this statement.
My statement today will present the views of the Independent
Petroleum Association of Mountain States (IPAMS) with respect to H.R.
3334, the Royalty Enhancement Act of 1988. IPAMS and its members
believe there is a distinct need for relief from the current royalty in
value system. IPAMS believes there are significant advantages to be
gained by requiring the Federal Government to take its oil and gas
royalties in kind rather than in value and avoid the wasteful, time
consuming and complex processes involved with the determination,
payment, and auditing of Federal royalty payments. My comments will
focus on why this change is imperative. My written testimony will
provide details of personal experiences I have had with the present in-
value system, particularly in the audit and settlement of Federal
royalty claims against lessees on Federal lands.
Until the recent enactment of the Federal Oil & Gas Royalty
Simplification and Fairness Act Public Law 104-185 (1996), most audits
were not commenced until an average of four to five years after the
royalty payments in question had been made. Thereafter, a lengthy
administrative appeal process delayed the final resolution of MMS
royalty claims for at least another three to four years within the
Department of the Interior. IPAMS believes that a royalty-in-kind
program will eliminate a substantial portion of this time consuming
delay in the resolution of audit disputes. Although the Federal Oil &
Gas Royalty Simplification and Fairness Act will now speed up the
process somewhat by requiring audits to be commenced within three years
from the date of payment, however, any MMS formal claim for additional
royalties is not barred until seven years from the date a royalty
payment was made. IPAMS submits that a royalty-in-kind program should
result in faster receipt of royalty revenues.
Under the current royalty-in-value system, a lessee who appeals a
royalty payment order has an election either to pay the disputed
royalties under protest and subject to appeal or post a surety bond or
irrevocable letter of credit. If the lessee elects the latter, then any
Federal royalty revenues to which the United States may be ultimately
entitled is postponed until the administrative appeal process has been
concluded unless the lessee and the MMS settle the case in the
meantime. IPAMS submits that with a royalty in kind program, the
Federal Government will receive its revenues much faster and avoid the
time consuming and costly process of disputed audits and contested
royalty payment orders. It is my understanding that the cost of the
audit and review process is nearly $60 million per year.
IPAMS believes that if the royalty-in-value program remains in
place, the audit process will become even more exacerbated and
difficult to administer because new and proposed royalty valuation
regulations have become more and more complicated and difficult to
administer for the small independent oil and gas producer. They will
create more cost and effort to apply these new regulations properly,
effectively and efficiently. They will necessitate the hiring of
qualified personnel or consultants to do this work for Federal lessees.
This additional cost becomes particularly onerous when the industry is
going through periods of price volatility in oil and gas markets such
as are being experienced now. For example, crude oil produced in the
Rocky Mountains is approaching historical low prices again forcing some
operators to shut in fields because the cost of production exceeds the
price being received for crude oil. Gas prices often experience similar
volatility.
As you are no doubt aware, the recently adopted MMS Gas
Transportation Allowance Regulations have been challenged in a Federal
court in Washington DC. That challenge has been mounted for the very
reason which I have just spoken: the regulations are complex, difficult
to administer, and vague and uncertain in many other respects. That
suit has been brought by the Independent Petroleum Association of
America, a sister organization of IPAMS.
New oil valuation regulations have been proposed and new gas
valuation regulations will be proposed by the MMS in the near future
which we understand are similarly complex. It is not beyond reason to
expect that these regulations may also be challenged in the courts for
many of the same reasons that the transportation allowance regulations
have been challenged. This opinion is not intended to be a threat of
litigation but only an educated guess.
The new MMS approach in these regulations flies in the face of two
fundamental principles of royalty valuation at the Federal level.
First, since the enactment of the Mineral Leasing Act of 1920 over
nearly 78 years ago, royalty valuation on Federal (as well as private)
leases have been guided by the principle that gross proceeds received
under arms-length contracts in the field or area of production
determine market value and consequently set the value for royalty
payments. The 1988 MMS Royalty Valuations Regulations continue to
observe that principle by recognizing that interaction of market forces
in a free and open market in the general area of production is the best
determination of value 53 F.R. 1182, 1187 (Jan. 15, 1988).
Second, ``a netback'' method to determine royalty is proper only
where other methods cannot be used to calculate a wellhead or a
leasehold value because of the lack of comparable values in the field
or area of production. The auditors' approach that I have described is
a netback method that improperly ignores the availability of other,
more reliable, valuation methods. Moreover, the auditors' approach goes
far beyond even the acceptable reach of netback calculations. In fact,
when the Department adopted the 1988 Royalty Valuation Regulations it
admitted the netback approach was the least desirable method of
valuation 52 F.R. 1183 (1988). It specifically rejected a proposal to
use a net-back methodology on a routine basis to check against prices
received under arm's-length contracts. MMS stated: ``To routinely
perform labor-intensive net-back calculations is impractical.'' 53 F.R.
1182, 1186 (1988).
The Mineral Leasing Act of 1920 provides that royalty from onshore
Federal leases is a percentage of the ``value of the production removed
or sold from the lease.'' The term ``value'' as used in the Mineral
Leasing Act means the ``reasonable market value;'' that is a price
which a product will bring in an open market, between a ``willing
seller and a willing buyer.'' In addition, the Act defines the point at
which value is determined, namely, at the wellhead or some other point
within the lease boundaries. Therefore even though an affiliate
transaction may be occurring, the foregoing laws still require the use
of reasonable market values when present in an open market in the field
or area.
At this juncture I want to describe some cases and other events
with which I've had direct experience which demonstrate the failure of
the in-value system. Most of these examples will show that some
auditors do not apply the existing valuation regulations properly
because of the lack of proper training or experience or that they
simply ignore the regulations in order to base royalty values on prices
received in distant markets located well beyond the field of
production. Most IPAMS members sell Federal production in arm's-length
contracts at the wellhead but in some instances independents may sell
production to either a gathering affiliate or a marketing affiliate.
When affiliate sales occur they are treated as a non-arm's length
contract under the regulations. Current regulations provide that
proceeds received by the lessee in non-arm's length transactions will
be acceptable for royalty purposes if prices received are equivalent to
comparable arm's length sales in the same field or area according to a
hierarchy of benchmarks. Current MMS policy provides that a resale
price received by an affiliate is another price which is factored into
the benchmark analysis but only if the resale occurs in the same field
or area. However, in the cases described below, the auditors have not
followed this policy but have ignored prices received in arms-length
contracts in the same field or area of production and have used prices
received by the affiliate which are derived from resales into markets
far distant from the field of production.
The first example involves an independent producer who has a
marketing affiliate. Its marketing affiliate buys and sells not only
gas produced by its affiliate but also buys and resells gas produced by
unaffiliated third parties. In 1993 the producer sought a value
determination from MMS under applicable regulations to establish as the
value for royalty purposes published index prices in the same field or
area.
The request was denied and the MMS ordered the lessee to apply the
benchmark regulations. The lessee complied and filed the appropriate
reports with the MMS. In 1996 the lessee was audited and ordered to pay
additional royalties. The MMS' claim for additional royalties was not
based on any errors in complying with the MMS order but solely upon the
perceived failure of the lessee to compute and pay royalties on resale
prices its marketing affiliate received in distant, out of state
markets. Shockingly, the order to pay stated that the lessee was
``seeking to avoid payment of its royalties'' by using values derived
from benchmarked arms-length sales in the same field or area. The
auditors did not follow the valuation order of the MMS. The lessee was
shocked to receive such a statement and asked the obvious question. How
can one be accused of avoiding the payment of royalties when they
complied with an MMS order? I seriously doubt whether the MMS order was
given to the auditors until the lessee provided them with a copy of the
valuation determination during an audit visit. The lessee has requested
that because of the auditors statement quoted above the audit is
prejudiced, the auditor should be removed and MMS should reperform the
audit.
In another case the lessee, a small independent, sold gas to its
gathering affiliate and once again based its royalty calculations on
third party arms-length sales in the same field or area. Once again,
the auditors rejected such prices and issued an order demanding that
additional royalties be paid on downstream prices at an interstate
transmission connect point out of the field or area of production. The
auditors did not accept comparable arms-length prices in the same field
or area and misapplied MMS policy on affiliate resales.
The third case involves a similar situation and in particular
involves the use of gas index prices published in Inside FERC, a
nationally recognized publication which lists prices paid by shippers
on interstate gas transmission lines throughout the United States.
Again, the auditors refused to accept these prices even though the
lessee was paying royalties based upon a price which was a premium
above the published index price for gas in that field or area. Instead
the auditors based claims for additional royalties on resale prices
received by the affiliate in markets which were located in several
states and several hundreds of miles away from the field of production.
In another instance of flawed auditing, the auditors refused to
allow a lessee to exclude volumes of gas put to beneficial use (as
permitted by the Bureau of Land Management under Notice to Lessees No.
4-A) from volumes reportable for royalty purposes. The auditors
confused that exclusion with another regulation of the MMS which
prohibits lessees from deducting a proportionate share of any costs
relating to gathering, dehydration, compression or other expenses
incurred in conditioning the gas for market. In this case the auditors
treated the value of the beneficial use gas as a conditioning cost and
added that value back into the reportable royalty volumes. Under
Federal regulation production which is used to enhance production, its
delivery or which otherwise benefits the lease is not subject to
royalty.
The lessee appealed the issue but the MMS Director denied the
appeal. Thereafter, an appeal was taken to the IBLA but the appeal was
dismissed because the lessee's law firm lost the certified mail
receipts establishing the timely filing of the appeal with IBLA. Under
Departmental regulations proof of timely filing is jurisdic-
tional. Thereafter the lessee sued the law firm for malpractice and was
successful. The Court found that if the appeal been timely filed, the
lessee would have prevailed on the merits. I testified on behalf of the
lessee that the audit finding was erroneous and contrary to applicable
regulation.
This pattern of improper auditing has become very consistent lately
and other cases of which I'm aware indicate that a subtle unpublished
change of policy is occurring within the Department to which lessees/
payors are not privy until they are visited by auditors. It appears to
me that MMS's policy is to ignore arm's-length values present in the
field or area of production and instead turn to downstream values
received in distant markets without any authority to do so. The MMS
policy is to ignore entirely comparable arms-length sales in the field
or area and to seek the benefit of the downstream values without
sharing in the risk of getting the product to that market and obtaining
the higher price.
In effect, this policy pierces the corporate veil of the affiliate
contrary to established departmental precedent. In the case of Getty
Oil Co., IBLA 80-430, 51 IBLA 47 (1980), the Interior Board of Land
Appeals held that while interaffiliate transactions should be
scrutinized carefully, they may nevertheless represent a fair price if
the price is comparable to arm's length prices paid in the same field
or area. The Getty decision also stated that before the interaffiliate
sales transaction could be rejected, it was incumbent upon the
Department to establish that the downstream affiliate was not a valid,
subsisting and properly maintained corporation but was a sham or
artifice to promote fraud and injustice.
The Getty Oil Co. case remains controlling precedent in the
Department and has not been overruled or reversed by the Department or
by the courts. This example demonstrates the lack of training of
auditors with respect to a crucial issue in audits of affiliated sales.
It may also demonstrate that the Department may be anticipating the
adoption of proposed regulations before either their formal publication
for rulemaking or final adoption. While most of our members are small
independents who sell their production from Federal lands in arms
length transactions, many of them have to establish gathering companies
to get their production to a market because purchasers are not willing
to invest in pipelines to gather production in the field. When the
lessees sell the gas to the gathering affiliate and immediately they
encounter the problems which I have just described in any audits by
MMS.
These cases are also examples of ignoring prior Congressional
policy with respect to the valuation of gas. In 1987 Congress passed
the Notice to Lessees No. 5 Gas Royalty Act (Public Law 100-234) which
was necessitated due to falling prices for gas that was subject to
price regulation under the Natural Gas Policy Act (``NGPA''). Under the
latter Act Congress established maximum ceiling prices for various
types of natural gas. Upon the enactment of the NGPA, the Department of
the Interior issued Notice to Lessees No. 5 which required the lessees
to pay on the higher of either the price received by the lessee or the
price established by the NGPA for that particular category of gas.
In the early 1980s gas prices suffered a substantial decline
because pipelines were marketing out under their existing contracts and
refusing to pay the prices established by the contract and by the NGPA.
MMS attempted to resolve this problem by removing the requirement of
paying on the NPGA price if the lessee was not receiving it. This
created considerable tension among the state and Indian royalty
recipients. However, the Notice to Lessees No. 5 Gas Royalty Act
alleviated the tension by providing that NGPA prices were no longer
mandatory if they were not being received by producers. The Act further
provided that market prices received in arms-length transactions in the
same field or area would be acceptable for royalty value purposes even
if such prices were below the maximum lawful ceiling price established
by the NGPA. The oil and gas producing states of the United States
entered into a compact with this valuation principle as its cornerstone
and it was upon this principle that Congress enacted the law. IPAMS
submits this Congressional policy will be fostered through royalty-in-
kind.
If the MMS continues to insist on seeking the benefits of
downstream prices without sharing in any of the risks, it is reasonably
foreseeable that litigation will only increase because of industry's
opposition to the new MMS approach. This will cost the taxpayers of the
United States a great deal of money.
Recently the Department of the Interior published proposed
regulations for the valuation of crude oil. While these regulations
continue to recognize gross proceeds received under an arms-length
contract as value for royalty purposes, the proposal introduces a
troubling element which may cast some doubt over the acceptance of such
prices depending upon how the ``duty to market'' proposal will be
viewed by auditors in the future.
IPAMS recognizes that every oil and gas lease has at least an
implied duty to market, but in light of the manner in which auditors
have approached valuation in the cases I have described to you, IPAMS
is concerned that an audit may seek to second guess the decision from
the always advantageous position of hindsight. If this approach is
taken, I can only predict further tension and potential litigation over
this issue.
However, this can be avoided entirely by enacting RIK legislation
and requiring the government to take its royalty in kind. The Federal
Government has tremendous quantities of oil and gas. According to
financial information published by MMS, Federal oil and gas royalty
revenues for the fiscal year 1996 were well over $5 billion. With such
vast quantities of production to market, I believe the Federal
Government can reap even greater benefits through an in kind program
and minimize the expensive, time consuming and contentiousness which
exists in the current regulation of royalty valuation. With such
substantial volumes at its disposal, the Department will be one of the
biggest aggregators of large volumes of production for sale into the
market. It will command higher prices received under an in-value
system.
In their further quest to find new reasons to change existing
valuation regulations, the MMS investigated the use of oil valuation
techniques employed by foreign countries. MMS officials visited Norway
and studied the practices of the Norwegian Oil Pricing Board
(``NOPB''). In Norway a panel of Norwegian government employees sets
the price of oil. After research into world oil pricing information and
other information which might influence the price of oil, the NOPB
dictates the price. This is the only piece the NOPB will accept from
producers. This technique can hardly be called determining price or
value through the interaction of market forces. In my judgment this is
not appropriate for the market-based economy in the United States.
Finally there is another reason why I believe royalty-in-kind is
the way to go. I am IPAMS representative on the Royalty Policy
Committee of the Department and served as the Chairman of its Appeals
and ADR Subcommittee. The Royalty Policy Committee recommended
substantial revisions to the administrative royalty appeal process. The
recommendations seek to eliminate appeals to the Director, MMS and
instead to limit those appeals directly to the Interior Board of Land
Appeals. Appeals to the Director are time consuming, unnecessary and
are fraught with all of the shortcomings in any agency's review of
subordinates' decisions. The proposal was accepted by the Secretary and
upon the adoption of a final regulation, appeals will go directly to
the IBLA who will make the final decision for the Department. The IBLA
was created as a result of the work of the Public Land Law Review
Commission which saw the need for a quasi-independent tribunal within
the Department to review decisions so as to avoid litigation in the
Courts. This Commission was established by the Congress of the United
States and Representative Wayne Aspinall of Colorado was Chairman of
the Commission. The work of the Commission also led to the passage of
the Federal Land Policy and Management Act. IPAMS supports the
maintenance of IBLA in the function for which the Commission designed
for it. Occasionally rumors filter back to us in the Rocky Mountain
states that the Department may seek to eliminate the Board. If this
happens, I believe it is all the more reason to implement a royalty in-
kind program because more expensive court litigation could possibly
ensue.
IPAMS believes that the illustrations I have discussed are inherent
in any royalty program based on an in-value system. The real reason is
because no one has been able to adequately define the term ``value.''
In reality it is a hypothetical, difficult of ascertainment, definition
and resolution. The difficulty is best described by the following
quote:
Men have all but driven themselves mad in an effort to
definitize its meaning . . . . the word ``value'' almost always
``involves a conjecture, a guess, a prediction, a prophecy. . .
. We cannot, by the use of a symbol, ``value'' convert the
risky into risklessness. . . . Indeed, ``value'' because of its
troubled history, evokes such a multitude of its troubled
history, evokes such a multitude of conflicting associations
that it might be well to abolish its use in legislation and
judicial opinions. Andrews v. Commissioner of Internal Revenue,
135 F.2d 314 (2nd Cir. 1943)
Interestingly the 1988 Royalty Valuations recognized this
difficulty and cited this same case. 53 F.R. 1233 (1988). Thank you
again for the opportunity to present IPAMS views regarding this
legislation. I will be happy to answer any questions.
Supplement Sheet to IPAMS Statement
Hugh V. Schaefer, Esq.
Welborn Sullivan Meck & Tooley, P.C.
1775 Sherman Street, Suite 1800
Denver, CO 80203
(303) 830-2500
The Independent Petroleum Association of Mountain States
(``IPAMS'') recommends the enactment of Federal Royalty-in Kind
Legislation requiring the Department of the Interior to take
Federal oil and gas royalty in kind rather in value. The in-
value program currently in effect is time consuming, costly and
delays collection of Federal royalty revenues because of the
numerous administrative appeals pending within the Department.
Auditors are not adequately trained to fully understand
applicable laws and regulations which they must follow in
conducting audits. The changing and increasingly complex
environment in oil and natural gas markets dictate the adaption
of a system which is equipped to deal with this changing
environment.
The United States commands vast quantities of oil and gas
and through aggregation, the United States is in a particularly
advantageous position to realize greater revenues by
controlling and directly market such vast quantities of
production.
------
Statement of L. Poe Leggette, representing the Independent Petroleum
Association of American and the Domestic Petroleum Council
The standard for royalty valuation is simple. The
Department of the Interior is to obtain the fair market value
of the oil or gas at the wellhead. To this the Department has
added the qualification that ``[u]nder no circumstances shall
the value of production for royalty purposes be less than the
gross proceeds accruing to the lessee for lease production. . .
.'' 30 C.F.R. Sec. 206.152(h). Exactly what constitutes ``gross
proceeds,'' is quite a different question and has given rise to
innumerable controversies between the United States Department
of the Interior (the ``Department'') and the oil and gas
industry. The most contentious of these disputes are briefly
summarized.
1. Royalties on Contract Settlement Proceeds.
The origins of this dispute go back to the early 1980s. Two
Federal circuit courts of appeals have addressed the issues and
reached differing, though not necessarily inconsistent,
results. IPAA v. Babbitt, 92 F.3d 1248 (D.C. Cir. 1996); United
States v. Century Onshore Mgmt. Corp., 111 F.3d 443 (6th Cir.
1997), cert. denied, -- U.S. -- 118 S. Ct. 880. At least twelve
other cases concerning royalties on contract settlement
proceeds were filed in the United States District Court for the
District of Columbia and hundreds of administrative appeals are
pending. Under typical oil and gas sales contracts, the buyer
agrees to pay for a certain minimum volume of gas per month or
year whether or not he actually takes delivery of that volume.
Frequently, purchasers make lump-sum payments to resolve
accrued take-or-pay liabilities and alter the future
relationship of the parties. When the payment reduces the
future price of production, it is known as a buydown. If the
settlement payment terminates the contract, it is a buyout.
Some of these payments are recoupable over subsequent years
while others are not. In the early 1980s, the Department's
position was that royalties were due on take-or-pay payments
under natural gas sales contracts when the lessee received the
payment and on take-or-pay settlement payments when they were
received.
After the Fifth Circuit's ruling in 1988 that ``royalties
are not owed unless and until actual production, the severance
of minerals from the formation, occur,'' the Department changed
its regulations to require royalties only when make-up gas is
taken, i.e., the payment is recouped. Diamond Shamrock
Exploration Co. v. Hodel, 853 F.2d 1159, 1165 (5th Cir. 1988).
In May 1993, the Department announced that it would assess
royalties on recoupable and nonrecoupable take-or-pay contract
settlement payments which ultimately led to the current
dispute.
The DC Circuit's decision in IPAA v. Babbitt prohibits the
assessment of royalties on nonrecoupable buyouts and buydowns.
The Sixth Circuit's ruling in Century Onshore Mgmt. Corp.
allows the assessment of royalties on at least one type of
contract settlement when there was no breach of the contract
prior to settlement and production was sold to the original
purchaser after the settlement. The Department, however,
continues to issue orders to producers assessing royalties on
both buyout and buydown proceeds.
Affiliate Resales.
In Shell Oil Co. v. Babbitt, 125 F.3d 172 (3rd Cir. 1997),
the Third Circuit ruled that the Department's Minerals
Management Service (``MMS'') could require an affiliate
purchaser (one affiliated with the producer seller) to produce
records of its arm's length resales so that MMS could determine
whether the producer was properly valuing production in
compliance with the lease terms and regulations.
Similarly, in Santa Fe Energy Products Co. v. McCutcheon,
90 F.3d 409, 414 (lOth Cir. 1996), the Tenth Circuit ruled that
``[u]nder the gross proceeds rule, the MMS could reasonably
require information relating to [the affiliated purchaser's]
sales in order to ascertain the oil's fair market value and to
determine the gross proceeds accruing to [the producer].''
The Department of the Interior has now applied the Shell
and Santa Fe cases to assess royalties on a lessee by using the
downstream resale price of its affiliate. In Xeno, Inc., 134
IBLA 172 (1995), some of the lessees producing in the Battle
Creek gas field in Montana, unhappy with the wellhead price
offered by two prospective purchasers, formed a joint venture
to construct a gas gathering and transportation system to move
the gas to an existing pipeline connection point. The joint
venture bought the gas at the wellheads from the lessees,
shipped in downstream, and resold it. Per unit of gas, the
difference between the resale price and the wellhead price was
about double the cost of building and operating the system. The
Department agreed that the lessees' gas was in marketable
condition at the wellhead. It also agreed that the lessees
received at the wellhead the highest price for gas that anyone
received in eastern Montana. The lessees were not required by
the leases or MMS regulations to build the gathering system to
market the gas. But because they did, MMS ordered them to pay
royalties on the profits the joint venture made from moving the
gas downstream for resale. This is a classic example of the
``uplift'' in price that a lessee can obtain by engaging in
midstream marketing activities. It also is a classic example of
the disincentive MMS creates for lessees engaged in midstream
marketing to undertake the risks and costs, knowing that MMS
will claim a royalty share free of those risks and free of most
of those costs.
3. Duty to Market.
The ``duty to market'' or ``duty to place in marketable
condition'' is a particularly contentious issue today and will
continue to be for many years to come. The Department's
position is that it is ``well settled that marketing expenses
necessary to market production from a Federal lease must be
performed at no cost to the lessor.'' Amoco Production Co.,
MMS-92-0552-OCS at 4 (1996) (citing California Co. v. Udall,
296 F.2d 384, 388 (D.C. Cir. 1961)). In this regard, the
Department recently issued a final rule on gas valuation, 62
Fed. Reg. 65753 (Dec. 16, 1997), and a proposed rule on oil
valuation. 63 Fed Reg. 6113 (Feb. 6, 1998). The gas rule
prohibits the deduction of many transportation costs which were
previously included in bundled FERC tariffs on the theory that
those costs are really marketing costs. The oil rule is also
designed to impose royalties on added value from midstream
marketing activities under the same theory.
The Independent Petroleum Association of America and the
Domestic Petroleum Council have strongly objected to this
codification of the duty to market because, although the duty
is ostensibly for the mutual benefit of the lessor and lessee,
the lessor does not share in the costs. Two trade associations
have filed suit challenging the final rule on gas
transportation. Independent Petroleum Assoc. of America v.
Armstrong, Civ. No. 98CV00531(RCL); American Petroleum
Institute v. Babbitt, Civ. No. 98CV00631(RCL). Oil and gas
producers have also submitted extensive continents on the
proposed oil rule as it has developed.
Recent decisions of the Department's Interior Board of Land
Appeals (``IBLA'') have also endorsed the lessee's duty to
market. In Texaco Inc., 134 IBLA 109 (1995), IBLA ruled that a
Federal lessee's duty to put lease production into a marketable
condition includes ``sweetening'' sour gas by removing hydrogen
sulfide. IBLA further held that the costs of sweetening the gas
are not deductible from the lessee's royalty base no matter who
performs the sweetening. In other words, the lessee always
bears the cost and the Department receives the benefit of
royalties based on the improved quality of the production.
In a case currently pending before IBLA, the Department has
taken the duty to market even further. In Amerac Energy Corp.,
IBLA 96--------- (appeal of MMS-93-0868-OCS), Amerac's
predecessor, Wolverine Exploration Company, entered a contract
to sell crude oil to Essex Refining Company. The terms of the
contract entitled Wolverine to 50 percent of the net profits
Essex received for marketing the gas. Wolverine paid royalties
based on its share of Essex's post-sale profits but did not pay
royalties on the portion of profits retained by Essex. MMS
thereafter challenged Wolverine's royalty calculation
methodology as failing to include ``the full consider-
ation received, directly or indirectly, for its sales of oil to
Essex,'' including the ``total value of marketing services
performed by Essex.'' MMS's position is that Wolverine also
owed royalties on Essex's share of the net profits because
Wolverine was simply paying Essex to market the oil.
4. Statute of Limitations.
Whether or not the statute of limitations at 28 U.S.C.
Sec. 2415 applies to MMS demands for additional royalties has
been litigated in various Federal courts since the early l990s.
Although the Royalty Fairness and Simplification Act of 1997
expressly creates a statute of limitations applicable to
royalty orders, it only applies to production after August
1996. Litigation over the applicability of section 2415 will
therefore continue over oil and gas produced before that date.
Section 2415 prohibits the United States from bringing an
action on a contract for money damages more than six years
after the right of action accrued. In 1993, the Tenth Circuit
agreed with the lessee that section 2415 applies to MMS demands
for additional royalties. Phillips Petroleum Co. v. Lujan, 4
F.3d 858 (lOth Cir. 1993). The Fifth Circuit subsequently
determined that royalty orders do not seek money damages and
therefore section 2415 does not bar the Department's attempts
to collect additional royalties due more an six years earlier.
Phillips Petroleum Co. v. Johnson, 1994 WL 484506 (5th Cir.
1994).
Since then the district courts have gone both ways.
Industry continues to challenge demands for royalties due more
than six years past due, and the government has advised one
company that it will use its pending case to relitigate the
issue in the Tenth Circuit. Shell Oil Co. v. Babbitt, Civ. No.
96-CV-1078-K.
5. Conclusion
Although the Department's program for taking the
government's royalty share in value has spawned controversy
from its inception in the 1920s, the program has never been
more contentious than it is now. Controversy is inherent in any
system of royalty in value, as this very brief review of the
current controversies illustrates.
------
Statement of the American Petroleum Institute, Mid-Continent Oil and
Gas Association, the National Ocean Industries Association and the
Rocky Mountain Oil and Gas Association
I. Overview
The American Petroleum Institute, Mid-Continent Oil and Gas
Association, National Ocean Industries Association, and the
Rocky Mountain Oil and Gas Association (``Associations'')
strongly support the concept of a mandatory and comprehensive
royalty-in-kind (``RIK'') program. The Associations believe the
recently proposed legislation (H.R. 3334) is the foundation for
creating an RIK system that simplifies and streamlines the
royalty collection process and provides benefits to the
government, industries, and the public. The Associations will
continue to work with Congress to improve and enact the
legislation.
A comprehensive RIK program, properly designed, is a means
by which the royalty collection system could be streamlined and
enhanced. By remitting royalty payments in kind (i.e., in
physical units) to the MMS at or near the lease, disputes over
the value of royalty production could essentially be
eliminated. The MMS would receive the value for its royalty
production directly by having its private marketing agents sell
the royalty production in transactions on the MMS' behalf.
Thus, the MMS and producers would benefit by eliminating what
has been and is a costly source of disputes.
II. Federal Royalty Disputes
The Federal and state governments, as well as private
landowners, have long collected royalties on oil and natural
gas production. While royalty disputes are not uncommon, most
Federal disputes have until very recently involved gas.
A 1996 Interagency Report led to an increase in Federal
audit activity for past valuation practices and Federal
rulemaking to address future valuation practices. Specifically,
the Minerals Management Service (MMS) in January 1997 proposed
a new basis for determining the value of oil production.
Supplemental proposals were issued in July 1997 and February
1998.
The oil and gas industry, including private royalty owners,
commented extensively on January 1997 proposal and the July
1997 supplemental proposal. The Associations believe the 1998
supplemental proposal is even more complicated and uncertain
and will file extensive comments by April 7. The valuation
methodology proposed by the MMS is neither simple nor certain.
The industry believes that a comprehensive RIK program
could provide the government with at least as much revenue as
it receives under the current system. Such an RIK program could
also benefit the Federal Government, states, industry, and
United States citizens by removing the contentious issue of
royalty valuation and simplifying the royalty collection
process. Indeed, a properly designed RIK program could increase
net revenues to the Federal Government through profits from the
value that may be added from time to time as its production
moves into the market downstream of the lease to the consumer.
Collecting Royalties
Traditionally, the Federal Government has collected most of
its royalties in value, i.e., cash payments under the terms of
the leases and current regulations. The amount received is
based on the value of production at the lease. For arm's length
transactions, the cash amount is based on the gross proceeds
received. For non-arm's length transactions, the cash amount is
based on imputed gross proceeds estimated by reference to
several benchmarks listed in the regulations (e.g., comparable
sales in the area). In either case, the royalty amount is
calculated by applying the applicable royalty rate to the
actual or imputed gross proceeds, less deductions for certain
post-production activities (e.g. transportation of oil and gas,
gas processing).
The MMS has stated that some of its goals in looking at the
new valuation method are (1) payment within 30 days after the
month of production; (2) certainty about the payment; and (3)
ability to verify payment easily. The MMS stated in its
February 5, 1998 News Release that ``Royalty must be based on
the value of production at the lease.''
In general, the MMS' present rulemaking addresses both
arm's length and non-arm's length contracts. For arm's length
contracts, it would narrow the definition of ``arm's length
contracts'' and thereby reduce use of gross proceeds as a
measure of the value of production. For non-arm's length
contracts, it would scrap the existing benchmarks altogether in
favor of some indexing scheme.
Specifically, the MMS' January 1997 proposal used a two-
region approach: Alaska North Slope (ANS) spot prices for
Alaska and California; NYMEX future prices for the rest of the
nation. In its February 1998 proposal, the MMS uses a three-
region approach: ANS spot prices for Alaska and California;
NYMEX prices and some other measures for the Rocky Mountain
Region; and spot prices for the rest of the nation. In either
case, MMS-established quality/location differentials would be
used in order to adjust the index prices.
Industry comments on the January 1997 proposal were
uniformly negative, asserting, among other things, that NYMEX
prices and ANS spot prices, when used in combination with the
MMS-set differentials, were not a sound measure of the value of
production at the lease, and that the definition of ``arm's
length contract'' was far too narrow. Industry comments on the
February 1998 proposal will be just as critical, scoring the
further complications of a three-region approach and
reiterating the problems with spot prices.
Valuation standards aside, industry comments will also be
critical of the MMS' February 1998 Proposal's expanded use of a
downstream proceeds tracing requirement that would be very
costly and, in some cases, impossible to implement.
Furthermore, the MMS proposals would establish valuation
procedures that are complex and shot through with the need for
interpretation by the lessee, to which the MMS would only be
willing to offer ``non-binding'' valuation determinations.
In a nutshell, the MMS crude oil valuation proposals are
neither simple nor certain and do not accomplish the MMS' own
stated objectives.
IV. Royalty-in-Kind as an Alternative to Royalty Valuation
Dissatisfaction with inadequacies of the MMS oil valuation
proposals and continuing disputes under the current system have
prompted Federal lessees to support an alternative: that the
MMS take its royalty in kind. Authority for using such an
alternative already exists in Federal leases. Briefly, the MMS
would receive its royalty in physical barrels of oil or cubic
feet of gas and would establish a process whereby private
marketers would bid to market this royalty oil and gas on
behalf of the MMS. MMS would directly receive the proceeds from
the sale of its royalty production. The government could
capture the value of any enhancements made to its royalty
production.
The Federal Government, states, industry, and the citizens
of the United States would benefit from reduced auditing,
accounting, and litigation costs. The current system of
auditing production value has given rise to protracted and
costly document retention and management, administrative
appeals and litigation as companies and the MMS have disagreed
on the interpretation and application of the regulations. The
case of Alberta, Canada is instructive: currently 33 employees
admin-
ister an RIK program that sells 146,000 barrels of royalty oil
per day. For a similar amount of royalty production, the MMS
employs hundreds more employees to interpret, account, and
audit under the current regulations.
V. Government Royalty Revenues Are Not at Risk Under An RIK
Program
Concerns have been raised that an RIK program would
jeopardize government royalty revenues. However, the states and
industry believe that a properly designed, comprehensive RIK
program would not lose money for the government. An RIK program
has the potential to provide additional revenue, especially
when one considers the benefits, such as reduced administrative
and monitoring costs, and acceleration of revenues. While MMS
has expressed doubts about RIK programs, it has not addressed
what a comprehensive RIK could achieve.
Vl. Principles of an RIK Program
1. An inter-association task force representing all
segments of the oil and gas producer community reviewed the
lease contracts, regulations, case law, other RIK programs, and
MMS reports on RIK. This task force also analyzed its own
experience with the RIK pilot and with other RIK situations. It
determined that a successful RIK program would reflect the
following principles which H.R. 3334 incorporates in most
respects:
1. An RIK program should reduce administrative and compliance
burdens while providing Federal and state governments an
opportunity to maximize the value of their royalty.
One of the motivating forces behind the effort to devise an
RIK program is the desire on the part of industry to reduce the
administrative and compliance burdens and costs currently
incurred by the MMS, states, and industry in the MMS valuation
process. This process includes audit, maintaining and providing
thousands of documents, explaining methods used, and correcting
MMS' misunderstandings, as well as those activities associated
with defending the interpretation and application of current
regulations on valuation of royalty oil and gas. MMS audits
often lead to disputes, and ultimately litigation, that require
a significant amount of time and expense to address. An RIK
program would eliminate most of the resources expended by the
MMS and by the lessees on administration and compliance.
It is important to emphasize that an RIK program does not
require direct participation in the oil and gas markets by the
MMS. This would be left to knowledgeable private marketers who
compete to sell the government's oil and gas and then arrange
for its transportation to downstream markets.
2. Lease obligations be fulfilled by transactions at or near
the lease.
Lease obligations require the royalty production to be
delivered in kind to the MMS at or near the well. Upon
delivery, the lessee's royalty obligations are satisfied. As
provided in the lease and under current regulations, the lessee
has no duty to market or transport royalty production once it
is tendered for delivery to the MMS. The MMS proposal moves the
valuation point downstream of the lease. This proposal imposes
additional costs on lessees, which are not required under
current leases and MMS regulations. Under the RIK program, the
marketing agent who takes delivery of royalty production on
behalf of the government should assume risks and costs outlined
in the contract between it and the U.S.
3. The government should take its full share of royalty in
kind.
One of the primary goals of an RIK program is to design and
implement a comprehensive Federal royalty management program
that can be administered for all Federal production. Certainty
and simplicity are also major goals of an RIK program. To
accomplish these worthwhile goals, a mandatory RIK program is a
prerequisite. Without a mandatory program, there would be
additional burdens such as: the administration of dual
accounting systems, one for royalty in kind and one for
valuation; continuing disputes over the complex and unclear
valuation methodologies being proposed; and higher costs to
states receiving net profit interests because of the resulting
overhead. Finally, mandatory RIK allows for aggregation of U.S.
Federal production in areas and regions with low volume wells
which can be a benefit in marketing the U.S. share of
production.
4. The government should rely on private marketing agents to
dispose of its royalty production.
There is no need for the government to become involved in
the business of transportation or marketing of its royalty
production. Having the government (i.e. the MMS) market its own
production is unworkable and inefficient, as pointed out in the
MMS' 1995 offshore RIK pilot project. Additionally, competition
among knowledgeable private marketing agents is sufficient to
enable the government to receive a market driven price for its
royalty share of production. Marketing agents can ag-
gregate volumes, invest in the marketing of oil and gas, and
arrange for transportation. In effect, the government will let
private firms bid to undertake these activities, just as it
allows private firms to bid for the right to explore for and
produce oil and gas.
5. States should have the opportunity to assist in the design
and implementation of an RIK program.
In general, states receive one-half of the proceeds from
any Federal onshore oil and gas royalties located in the state
and twenty-seven and one-half percent for some Federal offshore
lands (Section 8g lands). These proceeds are netted by overhead
deductions determined by the Federal Government. Thus, states
stand to share in any benefits effected by an RIK program, that
reduce this administrative overhead. Some states (Wyoming) have
actively promoted an RIK program or have put a limited RIK
program in place (Texas).
6. Royalties taken in-kind should be broadly available for
public purchase.
Oil and gas royalty production should be made available on
a competitive basis to a broad-based market. No entity should
be excluded from having the right to purchase the government's
royalty share of production.
VII. Issues Raised by the RIK Proposal
The proposal to implement a comprehensive RIK program has
raised a number of additional issues. One issue is whether
government sales of its oil and gas royalties might be
disruptive to petroleum markets. Here, it must be recognized
that the unit of production taken in kind by the U.S. is not a
new unit in the market and thus should not affect supply and
demand.
Another issue is whether an RIK program implies direct
government involvement in the oil and gas industries. By
allowing private marketing agents to handle sales of royalty
production, the government avoids direct involvement of its
employees who do not possess the requisite marketing expertise.
These private marketing agents would be firms with the
expertise to find the markets where oil and gas is most highly
valued. In effect, the government could collect its royalty
revenues from private marketing agents rather than from
lessees. Hence, government involvement can be decreased,
resulting in cost savings to the taxpayer while net revenues to
the government are increased or, at worst, unaffected. An RIK
program could be analogous to the Federal leasing of acreage to
private firms for oil and gas exploration and production. The
government is not engaged in exploring for and producing oil
and gas. Rather, private firms with the highest bid win the
right to explore and produce from the Federal lands.
Any affiliation the qualified marketing agent and lessees
or between the qualified marketing agent and the purchaser is
irrelevant as long as the sales process is open, competitive
and nondiscriminatory to all potential buyers. It is the open
process, not the affiliation or lack of affiliation between
such parties, which assures that the MMS will maximize receipts
for sale of its royalty share. Any proscription against
affiliated qualified marketing agents or purchasers could
actually reduce MMS' royalty revenues by eliminating those who
might compete in the bidding for or in purchasing royalty
production.
VIII. Concluding Remarks
A comprehensive RIK program permits the government and
producers to reduce the administrative and compliance costs
associated with the payment of royalties. By eliminating the
current royalty valuation system, and streamlining the royalty
collection process, an RIK program can benefit all parties. The
Associations believe that the legislative proposal for an RIK
program is on the right track and are examining the legislation
to determine whether it should recommend any modifications.
------
Letter from the Domestic Petroleum Council to Hon. Thornberry
The Honorable Mac Thornberry,
412 Cannon House Office Building,
Washington, DC 20515
The Domestic Petroleum Council (DPC) strongly supports a
comprehensive, mandatory, royalty-in-kind program for Federal oil and
gas resources.
As a result, the large independent natural gas and crude oil
exploration and production company members of the DPC would appreciate
your including this letter in today's House Energy and Minerals
Subcommittee hearing record to demonstrate that they:
<bullet> strongly support H.R. 3334, the Royalty Enhancement
Act of 1998 you introduced with Representatives Barbara Cubin
and Kevin Brady as cosponsors;
<bullet> appreciate Subcommittee Chair Cubin's holding today's
hearing as the next step in the public policy process to
explore why and how a royalty-in-kind, or RIK, approach will
maximize benefits to our citizens and reduce or eliminate
inefficient and costly disputes and litigation over royalty
valuation;
<bullet> urge prompt markup of this legislation; and,
<bullet> commit to working with others who have an interest in
the Federal royalty program to improve H.R. 3334 at each stage
of the legislative process until a sound RIK program is in
place.
Regrettably, the current Federal oil and gas royalty program is a
mess. For our members the Federal Government is often, in effect, one
of our largest partners in developing oil and gas resources. But
regardless of their commitment to pay the Federal Government every
penny owed in royalties, our members face constant uncertainty and
threat of audit, non-productive reexamination of royalty valuation
decisions, and litigation, under the current royalty program.
Worse, the Minerals Management Service has proposed most recently a
series of sweeping changes in the crude oil royalty program that would
in many instances add greater uncertainty and audit exposure. The
various changes proposed, then modified, re-proposed and once again the
subject of further comment, have been based on too little understanding
of today's oil markets. The most recent oil proposal is also the latest
of the MMS efforts to change the fundamental contract producers rely
upon to find and produce energy for the nation from Federal lands. Our
members have spent enormous amounts of time, energy and resources to
help educate MMS personnel, outright oppose many of the MMS ideas, and
to offer counter proposals to others, with little success.
Witnesses before you today and in the future will explain in detail
the shortcomings of the current royalty program and the attempts to
change it. But the overall message will be that it is time for a basic
change in our entire royalty approach.
It is time to end uncertainty over royalty value.
It is time to sharply reduce the number of Federal employees it
takes to try to monitor, track and second-guess dynamic market
transactions that are necessary in a changing and increasingly complex
energy market.
It is time to cut down on litigation expenses that sap both
government and company staff time and budgets.
It is time to harness the market to enhance Federal oil and gas
royalty production value just as the market does in the sale of
millions of barrels of oil and billions of cubic feet of natural gas
for the private sector every day.
It is time for the Federal Government to take its royalty share of
production in kind, and to encourage professional, private sector,
marketers to compete to sell it at the highest prices the market will
allow.
It is time for a comprehensive and mandatory royalty-in-kind
program.
We urge your continuing efforts to put such a program in place.
One word of encouragement about the financial bottom line of an RIK
program. The DPC members know that such a program must return as much
revenue to the Federal Government as does the current program in order
for it to be adopted. We firmly believe that a good program will do
that and more. And we welcome solid analysis of those financial
implications.
We also know that others who do not understand today's energy
markets, or who oppose a change in the status quo for various reasons,
will be quick to claim that an RIK program does not meet the revenue
test. We are confident that the Energy and Minerals Subcommittee and
others in Congress will ask the necessary questions about the
assumptions used in developing such claims so that they can be fairly
evaluated and the economic benefits of a RIK can be fully recognized.
The Domestic Petroleum Council looks forward to working with you
and your colleagues toward the RIK program the country needs.
Thank you.
Sincerely,
William F. Whitsitt,
President
HEARING ON H.R. 3334, THE ROYALTY ENHANCEMENT ACT OF 1998
----------
THURSDAY, MAY 21, 1998
House of Representatives, Subcommittee on Energy
and Mineral Resources, Committee on Resources,
Washington, DC.
The Subcommittee met, pursuant to notice, at 1:18 p.m., in
room 1334, Longworth House Office Building, Hon. Barbara Cubin,
[chairwoman of the Subcommittee] presiding.
STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF WYOMING
Mrs. Cubin. The Minerals and Resources will please come to
order.
The Subcommittee meeting today is meeting today to hear
testimony on H.R. 3334, to provide certainty for, reduce
administrative and compliance burdens associated with, and
streamline improved collection royalties from Federal and Outer
Continental Shelf oil and gas leases, and for other purposes.
The Subcommittee meets today to take testimony on H.R.
3334, a bill to reduce administrative compliance burdens
associated with the collection of royalties from--yes, we
repeated ourselves here. So I'll just read to myself and then
skip.
[Laughter.]
And I am sure you can all hear what I am thinking. I think
he can, too.
Two months have elapsed since our first hearing, and if
nothing else, this bill certainly has engendered much debate in
the trade press and occasionally even in the popular press.
Unfortunately I really believe that the rhetoric has escalated
way beyond the rational discourse of the merits of the bill and
almost to the point of name-calling between the government and
industry.
This is not helpful to those of us in Congress charged with
oversight of the issue and who want to tackle an obvious
problem and search for common sense solutions. That truly is
the goal here today.
The oil industry flexed its muscles with appropriators a
few weeks ago to delay the publication of crude oil valuation
rule. The sparks flew over that. The rider that was put on the
Appropriations bill, and I believe that the rule will surely be
litigated when it does go into effect or if it does go into
effect because it is such a large departure from decades of
practice by the Department of the Interior.
However, the market uplift envisioned in that rule, some
$66 million per year, is something which the sponsors of this
bill, myself included, want to utilize to benefit the Federal
and State treasuries by putting private marketers to work for
Uncle Sam. We can get that value-added increment by taking in-
kind volumes aggregated from many leases to downstream
marketers, and do so without the litigation fight over whether
the Secretary has the authority to compel lessees to market
production at no cost to the lessor.
Now, I am pleased with the direction the formal revenue
estimates of the Department have gone since we last met from a
half a billion dollar annual shortfall preliminary estimate to
only one-seventh to one-third is, indeed, progress. And I
really trust when we are through here today we will see that
those estimates can actually turn into positive territory, as
indeed they must before any bill will come out of this
Subcommittee or even be marked up in this Subcommittee.
I think we have had a failure to communicate. My intent as
co-sponsor of this bill was not to use an RIK bill to overturn
precedents regarding proper processing and transportation
allowances. We have made that clear all along. And it was also
not to give treatment cost deductions which are not granted
under the current practice. I keep hearing that over and over,
and we've said all along that is not the case.
There can be no revenue consequence to those provisions of
the bill when our intent is known, and if the words don't say
it properly then it is incumbent on the MMS to help us write
the words so that they do say it properly.
Yes, there are a few places in the bill where we do intend
to change current rules; for example, the provisions for rate
of return for upstream pipeline investments, or for allowances
for affiliated pipeline transportation from actual costs to
market rates. But, let's calmly discuss why such a change may
or may not be warranted for deep water infrastructure
development, when investments in geothermal power plants are
granted such an advantage by MMS regulation.
I think most people will agree that a large fraction of our
Nation's energy supply for some time to come will be met by oil
and gas from increasingly more distant portions of the Outer
Continental Shelf, not from geothermal steam. So why don't we
take the opportunity to encourage pipeline building to get more
oil and gas onshore? But let's also get the real cost data
behind this idea. The industry will need to provide evidence to
when continuing support for such a change, and the time is
getting short.
I do intend to announce a Subcommittee markup of H.R. 3334
in the very near future. The 105th Congress is in session for
only a few more months, and the fiscal year 1998 funding
limitation provision expires in four months. There is good
reason for all sides to begin in earnest discussions. If the
Department of Interior believes it can simply stall away the
fiscal year and publish a final oil valuation rule without
further consultation from the Committee, they will not have
learned anything from their previous indifference to Congress,
and quite possibly find themselves stymied for 1999 as well.
On the other hand, if the industry is not forthcoming with
the kind of cost-benefit data necessary to sustain provisions
of this bill and clearly demonstrate the positive effects on
revenue it should have, well, then they better not look for
lightning to strike twice. An oil valuation rule will be
waiting for you on October 1st.
So I urge both sides to come forward with the information,
to talk together, because we are going to either have a
legislative solution to this problem or a courthouse gamble to
this problem.
I am ready to do my job to broker a compromise, but there
has to be some willingness by both parties to negotiate, and I
haven't seen very much of that, quite frankly.
Now that I have taken up more time than I should have, I'd
like to recognize the Ranking Member.
Mr. Romero-Barcelo. Thank you, Madam Chair. We have
previously heard from the Director of the Minerals Management
Service, and we'll hear again today the administration who is
strongly opposed to H.R. 1334, and they have indicated that it
would be vetoed by the President.
The economic analysis estimates that at very least $367
million will be lost per year if the bill is enacted, and this
estimate reflects only those costs that the Minerals Management
Services could extrapolate from the existing system. New
activities such as the small refiner provisions increase
litigation costs, imbalance provisions, triple volumes at
remote locations, marketing agent manipulation and oversized
supplied markets are not yet quantified.
Since the last hearing in March the States of Texas, New
Mexico and Alaska have provided written comments to the
Subcommittee which I submit for the record, and all three
states oppose the bill or major portions of it.
[The information may be found at end of hearing.]
Mr. Romero-Barcelo. In a related action the Justice
Department announced on Monday, May 18th, that the United
States has intervened against Texaco in the ongoing Quiatum
litigation. Quiatum or Quiatum, I don't know which one. I guess
it's Quiatum. The Quiatum litigation, filed under the False
Claims Act, was initially brought by private citizens in Texas
two years ago. Fourteen major oil companies were accused of
knowingly undervaluing oil extraction from public and Indian
lands.
In February Justice intervened against four companies, and
with this announcement the number of companies that the U.S. is
suing rises to five. The Quiatum litigation is part of the
growing hostilities between the Federal Government and the oil
industry or the value of Federal royalty oil and gas and how
much the taxpayer is sold.
The oil rider recently attached to the emergency
supplemental bill stops the Minerals Management Services from
issuing new regulations that would have respectively required
evaluations to be based on the published price of oil and gas.
Under the current system the oil companies use posted prices to
value their oil; however, they set those prices among
themselves. Critics of the current system assert that oil
companies purposely set low posted prices in order to lower the
royalty and their tax costs.
They negotiate separate but related exchange agreements
that equal the difference between the posted price and the
published index price. H.R. 3334 would fundamentally change the
way the Federal Government sells the Nation's oil and the gas
resources. H.R. 3334 would shift the cost for gathering, for
importing, for assessing and marketing Federal royalty oil and
gas from the oil industry from the taxpayers, and H.R. 3334, as
written, would result in a permanent reduction of Federal
royalty.
Clearly, and I believe the Chair agrees with it, H.R. 3334
will need extensive revision, as the chairwoman has indicated
before, it can be reported out of this Committee. And there are
serious pay-go issues that must be resolved, and there are
serious issues to be resolved.
Along the vein, our colleague, Representative Carolyn
Maloney, has offered an alternative for us to consider. Her
bill, the Federal Oil Royalty Protection Act, introduced today,
would codify the Minerals Management Service Rule, currently
blocked by a rider of the emergency appropriations bill. It is
my hope that the Chair will schedule hearings on this bill
before we markup H.R. 3334 so that we can consider both.
I look forward to hearing from our witnesses today, and
perhaps we will hear some recommendations for improving H.R.
3334. Thank you, Madam Chair.
Mrs. Cubin. Thank you. Mr. Thornberry.
Mr. Thornberry. Thank you, Madam Chairman, and the formal
statement that I would ask be made part of the record, and I
also would like to mention to you and my colleagues that after
the next vote I'll be detained on the floor for a bit because
of an amendment that will be considered there.
[The prepared statement of Mr. Thornberry follows:]
Statement of Hon. William M. ``Mac'' Thornberry, a Representative in
Congress from the State of Texas
Madam Chairman, I would first like to thank you for holding
this hearing today.
As you know, this is an important issue for me and one that
I have worked on for several years. I would like to again
restate my reasons for pushing legislation to mandate that the
government take its share of oil and gas royalties in kind
rather than in value.
<bullet> First, the current valuation system does not work. The
system is complicated, and provides no certainty for the
states, the taxpayers or the oil and gas industry. Moreover,
efforts to mend the system have created concerns by all parties
involved. In my view, if The Royalty Enhancement Act, H.R.
3334, before October 1, the Minerals Management Service will
publish a final rule that--regardless of its merit--will be
litigated for years to come. This, I believe, is a disservice
to U.S. taxpayers and the states.
<bullet> Secondly, I believe--like Ms. Quarterman has stated
before--that a well-designed and well-crafted royalty in kind
program can provide increased revenues for the states and
American taxpayers.
Litigation and confrontation does not benefit anyone. And while we
cannot put a dollar figure on the government's past, present, and
future legal battles with the oil and gas industry, I think it is safe
to assume that those costs will be substantial.
I have said many times that The Royalty Enhancement Act is a work
in progress--a starting point. From what I have heard over the last few
months changes are needed and warranted. I welcome constructive
criticism and suggestions on how to make this bill better.
I would also like to thank Ms. Quarterman and the Minerals
Management Service for their time and efforts in preparing their report
on the effects of H.R. 3334. While I disagree with some of their
findings, I do believe when we change this bill using many of their
suggestions, The Royalty Enhancement Act will receive a positive score.
Again, Madam Chairman, I thank you for holding this hearing today
and I look forward to hearing from the witnesses.
Mr. Thornberry. I want to make a couple of quick comments
in response to your statement and the Ranking Member's
statement. It does seem to me that the attention which the
moratorium has raised in the press and elsewhere proves to us
all that there has got to be a better way.
Mr. Romero-Barcelo mentions the growing hostility between
government and the oil companies. I think he is exactly right,
and trying to find the better way to reduce that hostility and
the litigation and the contentiousness which has enveloped this
issue is the reason that I got into this think to begin with.
And in accordance with your wishes, moving toward an markup
early next month with some changes and improvements in the bill
I think make sense, and I'll certainly intend to do that.
I also want to say briefly that I appreciate MMS's work and
coming to us since the last hearing with greater detail on
their comments and their cost estimates. I think they make some
good points in their analysis. I think there are some
misunderstandings, as you mentioned, and if they misunderstand
it, we need to take another look at the language and make it
even clearer on what we intend.
There are some errors. For example, they talk about the
Mensa Field in the Gulf as an oil field when in fact it's a gas
field. So there's some just clear errors, but we need to talk
about those and resolve them. And there is going to be
differences that we always have, and we will need to narrow
those.
I know that MMS will never support RIK legislation, but the
dialogue I think that has been going on is helpful to work out
some of these problems, to talk about how this program works
now, what some of the problems are, how this bill can be
improved and some of the pitfalls we face.
And so I think we are on a good track. I am encouraged, and
I appreciate other members of the Subcommittee working with us
as we try to find a better way.
Mrs. Cubin. Mr. Gibbons, do you have an opening statement?
Mr. Gibbons. Thank you, Madam Chairman. I would just like
to join my colleagues in welcoming our panels here today and
look forward to their testimony, and I applaud you in your
leadership in this effort.
I think royalty-in-kind is an issue of today. It's one
which I think is going to help us improve our competition in
the industry, whether it's oil and gas or whatever with our
overseas partners and in some times our overseas competitors in
this area.
If America is to remain competitive we have to move forward
with modernization of our oil and gas industry, including the
royalty-in-kind. And I think this bill, this effort, is going
to take a large step in that direction.
And thank you, Madam Chairman, once again for holding this
hearing, and I look forward to the testimony.
Mrs. Cubin. I too would like to express my gratitude to MMS
for sending the technical people over to work with the
Committee staff and work through that. It was very, very
helpful, and I think lots of things were uncovered. And we
know, as Mac said, we know that improvements need to be made,
and they will be, but thank you for that very much.
Now I would like to introduce our first panel. I routinely
swear in all the witnesses that in front of the Committee. So
we'll be doing that in a minute, but first I'd like to
introduce the Honorable Malcolm Wallop, United States Senator
from the greatest State of Wyoming, who is chairman of the
Frontiers of Freedom Institute. I also want to welcome Cynthia
Quarterman, the Director of MMS, who is accompanied by Debbie
Gibbs-Tschudy, Chief of the Royalty Valuation Division; and Mr.
Roger Vicenti, the Acting President of the Jicarilla Apache
Tribe.
[Witnesses sworn.]
Mrs. Cubin. Let me remind the witnesses that under our
Committee policy that testimony should be limited to 10
minutes.
So I will start with you, Senator Wallop.
STATEMENT OF MALCOLM WALLOP, A FORMER UNITED STATES SENATOR
FROM THE STATE OF WYOMING, AND CHAIRMAN, FRONTIERS OF FREEDOM
INSTITUTE
Mr. Wallop. Thank you, Madam Chairman, and let me offer my
appreciation to you for the invitation and express my real
pleasure at the honor of testifying in front of your
Subcommittee. I appreciate your invitation to testify on H.R.
3334, a bill to provide certainty, reduce administrative and
compliance burdens with, and streamline and improve collections
of royalties from Federal and OCS oil and oil gas leases.
I am Malcolm Wallop and serve as chairman of the Frontiers
of Freedom Institute, an independent, non-partisan public
policy research group, and I also have a stint here as
Wyoming's senior Senator from 1987 until 1995. As your
constituent and as a citizen of Wyoming, I have followed
recently the intensifying dispute over oil royalty and
valuation with increasing dismay.
And Madam Chairman, it's a troubling paradox of our time
that nearly a decade after the collapse of Communist centrally
planned economies the managerial state not only persists but
flourishes in the United States of America, where meddlesome
and intrusive regulations by bureaucrats almost defy compliance
and restrict human creativity. Both Republicans and Democrats
claim the era of big government is over, and the administration
talks about reinventing government, but overreaching by
government regulators not only remains the norm at the IRS but
throughout the government.
In the late Roman Empire the clerks and scribes of
officialdom were known as the ``clerisy,'' in distinction from
the clergy of priestly sector that was also economically
unproductive, at least in the material realm. In our day the
clerisy of officialdom in government finds its counterpart--its
mirror image--outside of government in a legion of lawyers and
lobbyists. These forces, contending over how much power to cede
to the regulators, do constant battle in both the legislative
and judicial arena.
The hard reality is that in the name of fairness, health
and safety, no segment of life or the economy is left private.
And worse yet, the only people judged capable of treating
citizens fairly and keeping them safe and healthy is modern
clerisy, the ruling class on the Potomac.
The endless night of regulatory rule making followed by
court battles enriches the clerisy of bureaucrats and the
lawyers at the expense of taxpayers and business people.
Consumers always end up bearing the cost of these wealth
transfers. A telling case is the current bitter and costly
dispute between the oil and gas industry and the MMS of the
Department of Interior over the valuation of petroleum
royalties due to Federal and State governments for oil and gas
extracted from public lands. Madam Chairman, an accounting
dispute ought not to be dragged down into the criminal courts.
Some people have a disagreement as to accounting. This is a
disagreement as to accounting and is a reflection of the
complexity of the regulations that neither side can interpret
consistently from one administration to the next, let alone one
decade to the next.
In our home State of Wyoming petroleum royalty payments are
set aside for education. The salaries of MMS auditors and the
fees of lawyers significantly reduce the net revenue available.
Regulators thrive on complexity and specialization. Simple
solutions are the natural enemy of power.
Earlier this year Frontiers of Freedom Institute
commissioned two well regarded energy economists, Dr. Walter J.
Mead, Professor Emeritus of the University of California at
Santa Barbara, and Dr. Robert Bradley, who heads the Houston-
based Institute on Energy Research, to develop a simpler, free
market approach to resolving the oil royalty valuation dispute.
I am pleased to submit these results, Madam Chairman, as part
of my official statement for the record.
[The information may be found at end of hearing.]
Mr. Wallop. And I do so with confidence that there are
simple solutions to apparently complex matters. In an
introduction to the Mead-Bradley Study, former Secretary of
Interior William Clark joins me in commending their analysis
for consideration.
Doctors Bradley and Mead begin their work by taking a fresh
look at the entire concept of royalty payments and advocate
sub-soil privatization as the optimal policy objective for the
long term. Their analysis is thoughtful and well reasoned. I
regret that circumstances did not permit either of the authors
to join us for the hearing, but their study traces the
evolution of the valuation controversy since the energy crisis
of the 1970's and the attempt by MMS regulators to return to
Carter-era energy market complexity where royalty determination
turns from objective, transaction specific cases into full
blown regulation and subjectivity.
The latest MMS rule proposal is predicated on imputed or
synthetic valuation and is imbued with command-and-control
central planning precepts. The large majority of Federal lease
transactions that the MMS has defined as non-arms's length,
their proposal would determine value at downstream points, in a
different market, from where it is contractually obliged to do
so. In effect they have changed the terms of the lease contract
by requiring that only some costs could be netted back to the
lease under specific rules. And only government gets away with
freewheeling breaking of contracts.
The authors identified payment of royalty-in-kind as a
workable compromise to solve today's valuation dispute. Under
such a sys-
tem, the government would take ownership of the actual
product--oil or natural gas--at the least and let qualified
marketers use their skill to maximize the return for the
government. A similar system in Alberta, Canada, enabled that
government to increase oil production, increase royalty
payments and significantly reduce the size of government
bureaucracy while eliminating--and this is important--disputes
between producers and the provincial government.
Now the Frontier of Freedom Institute is please to offer
what we believe is a fresh approach by scholars who are not
parties to the current controversy. And again, I thank you,
Madam Chairman, for allowing me the opportunity to appear
before your Committee and I would be happy to entertain any
questions.
[The statement of Mr. Wallop may be found at end of
hearing.]
Mrs. Cubin. Thank you, Senator Wallop.
Ms. Quarterman
STATEMENT OF CYNTHIA QUARTERMAN, DIRECTOR, MINERALS MANAGEMENT
SERVICE
Ms. Quarterman. Good afternoon, Madam Chairwoman and
members of the Subcommittee. I am pleased to return before you
today to continue discussing issues related to royalty-in-kind
programs for Federal oil and gas leases.
First, I'd like to offer some perspective on several issues
that surfaced during the Committee's last hearing. Then I will
briefly summarize our detailed analysis of H.R. 3334 which we
provided to the Subcommittee last month. One of the things I
mentioned to the chairwoman last time was that my knowledge on
the issues about an inch deep and a mile wide, so I have
brought with me today Debbie Gibbs-Tschudy who is the resident
expert on valuation issues. She's the Chief of the Royalty
Valuation Division in Denver.
First, I think it's important to review--in my view--how
far we have come in a short period of time in royalty
management. By providing some historic reasons why MMS was
created. As you know, MMS was created 16 years ago. Prior to
that time the Department of Interior was repeatedly criticized
for mismanaging the royalty program, because of its failure to
collect underpayments of hundreds of millions of dollars in
royalties every year.
An independent Commission on Fiscal Accountability of the
Nation's Energy Resources was formed to address those
allegations. The Commission recommended creation of an
independent royalty and minerals management agency to ensure
effective accounting, production verification, royalty
collection, and enforcement. Accordingly, MMS was established
and has since resolved the issues that were identified by that
commission.
Along the way MMS's royalty management program has
accumulated an enviable array of awards and commendations,
including the President's Council on Management Improvement
Award for management excellence. Just this past month MMS
reached the $2 billion mark in audit and compliance collections
from companies who have underpaid their royalties.
It's necessary to refer to this historical context because
at the time of MMS's creation the Commission urged that the oil
and gas industry should carry out its obligation as lessees to
pay royalties in full and on time. This statement goes to the
very heart of our concern with this bill, which is that it
disregards the Commission's recommendations or more pointedly,
its admonition, by forgiving the oil and gas industry of its
lease obligations to pay royalties in full and on time. By
relieving the industry of their long-established obligations
and denying the public its rights under the lease, this
legislation will return us to the days of when the public was
not assured of getting fair market value for its mineral
resources.
I fully understand the current debate. I believe that we
must look back to the original deal that was struck between the
United States, as custodian of the public's lands, and the oil
industry, as lessee. In that bargain, the United States
entrusts oil and gas lessees with the right to explore for,
develop, and produce minerals from Federal lands.
The lessee benefits by retaining most of the mineral
products from those lands. In exchange, the lessee agrees to
care for those lands and return to the United States a very
small portion of the proceeds in value or in-kind, at the
government's option. In addition, the lessee agrees
contractually to be bound by the government's reasonable
determination of what royalty value is. To eliminate the
government's choice in how to collect proceeds would deny the
public its rights under the lease and ultimately return less
than the fair value due and owing.
Last month we provided the Subcommittee with a detailed
analysis of the bill. Before answering any questions, I would
like to briefly summarize our conclusions concerning the bill.
In sum, this bill would drastically change the options and
legal rights of the Federal Government as mineral lessor and
hinder the government in its duty to assure a fair return to
the public. Certain provisions of the bill, such as those
addressing transportation cost reimbursements, will maximize
costs to the government and reduce royalty revenues
commensurately. We estimate that the government's costs of just
storing, processing and transporting the oil and natural gas to
the buyer, as proposed in this bill and which are now the
responsibility of the lessee, are at a minimum in the hundreds
of millions of dollars per year, while the administrative cost
savings are less than $8 million per year in the first eight
and a half years.
Our estimates for potential revenue effects vary from the
negative to tens of millions of dollars in theoretically
possible gains. However, any such potential revenue gains can
be realized without this legislation. MMS's existing right to
take royalties in-kind and our capability to do so, which is
being developed though our royalty-in-kind pilots, allows us to
realize all of the possible revenue gains for the taxpayer
without the costs associated with this legislation, and without
revenue losses from areas where RIK is not a feasible option.
Thus, as I testified earlier, H.R. 3334 will have a substantial
negative annual cost impact on the Treasury and will not
enhance revenue compared to current statutory ability.
It's also important to note that our analysis of the costs
associated with this bill are very, very conservative and do
not include a number of clearly negative provisions that we
could not quantify in the time that was available to us.
In contrast, the administrative cost savings used in the
analysis are very liberal because they do not take into account
the costs nec-
essary to start up and implement the royalty-in-kind provision
of the bill. In addition, the cost of contracting, overseeing,
and auditing qualified marketing agents under this bill could
easily wipe out the $8 million in administrative cost savings.
Another $6.2 million in revenues could also be lost through
the net receipts sharing provisions of the bill. Since the bill
does not explicitly rule out potential QMA conflicts or
conflicts of interest situations, our auditing and litigation
costs are likely to increase. In an opinion submitted by the
Department of Justice on this bill to the Office of Management
and Budget they concurred.
Finally, the potential revenue enhancement figures used in
the analysis are extremely generous because we assume ideal
conditions for royalty-in-kind program despite the provisions
in the bill which provide for the opposite.
H.R. 3334 will have a substantial negative annual impact on
the Treasury. Specifically we estimate increase in cost at a
minimum of between $183 to $368 million per year. This estimate
is comprised of the following items: Government transportation
would increase due to the assumption of payment for gathering
and to increases in the price paid for transportation. The
total increase, and you should have this in either a chart
before you or the chart here to my right doesn't spell these
out. It gives you the totals. It ranges from $77 to $136
million a year. Processing costs will increase some $4 to $8
million annually due to payment of higher commercial rates
rather than the lessee's actual costs. Treatment costs will
increase due to the assumption of field treatment processes
that are beyond the delivery point, which are estimated to be
between $85 and $178 million a year. Marketing costs will
increase between $17 to $46 million per year due to the
government assuming marketing costs.
These cost increases, plus several additional relatively
minor costs increases, are offset by a maximum of $7.3 million
in annual administrative savings and $36 million in maximum
theoretical annual revenue uplift due to RIK implementation.
Again, we realize any revenue uplift from RIK without this
legislation, and its substantial costs, under current
authorities, using a more deliberate approach. That is, we can
realize these revenue uplifts without the legislation.
Other provisions of the bill having a negative revenue
impact we could not quantify in the time available. They are on
the chart to my left and your right. From the above comments it
should be clear our position on the bill remains unchanged from
the last hearing. You have also heard concerns about this
legislation expressed by officials from the States of Texas and
New Mexico. I have heard from or my staff has heard from
officials from Louisiana, California and Alaska.
We believe that the time has come to agree on a more
productive course in our mutual desire to improve the royalty
management systems and to experiment with royalty-in-kind
options. In that spirit, I'd like to reiterate our request from
a year or so ago that the people directly involved in oil and
gas production, marketing, and accounting advise us and the
Committee on the options that are available for RIK before we
go forward with any legislation of this sort.
I noticed that many of the prepared statements of those
testifying today relate to our crude valuation rule, a matter
that I am not prepared to testify about here today, but I would
be more than happy to provide a briefing to the members of the
staff and their staffs on the crude oil valuation rule at your
pleasure.
That concludes my prepared remarks. Thank you.
[The prepared statement of Ms. Quarterman may be found at
end of hearing.]
Mrs. Cubin. Thank you very much.
Mr. Vicenti.
STATEMENT OF RODGER VICENTI, ACTING PRESIDENT, JICARILLA APACHE
TRIBE
Mr. Vicenti. Good afternoon, Madam Chairman, and members of
the Committee. I am Rodger Vicenti. I am the Acting President
of the Jicarilla Apache Tribe. Before I get into my statement I
would like to introduce some people that I brought along with
me. I have Councilman Hubert Valardi. I have the Department of
Taxation Director, Dave Wong. I have the tribal attorney Allen
Carterax, and a consultant attorney on oil and gas, David
Harris.
Mrs. Cubin. I'd like to welcome all of you folks.
Mr. Vicenti. Thank you. I've got a written statement here,
but I think it would be to our benefit to just explain to you a
situation that we've been through. We've been in the oil and
gas business for the last 50 years. And of the 50 years, the
last 20 years we've been active in this royalty-in-kind
revenue--and I can't think of the word, but I'll go on--where
we were getting our revenues from royalty-in-kind, and the
reasons it worked for us at that time was the conditions were
there. We were able to establish a set ratio where we would get
a certain amount of money for oil that was being produced, and
while that lasted it was real beneficial to the tribe.
The thing that we would like to express to the Committee is
that the government should consider putting themselves, you
know, them having an option to give themselves either royalty-
in-kind or royalty-in-value. We have that option today so we
can decide what direction we want to go to that is more
beneficial to us.
I understand that this law or this bill does not really
affect the tribes. It is intended not to affect the tribes, but
it does affect us in the way the policies are followed, if
there an entity that is off the reservation that have been able
to get their oil and gas at a lower price that would take our
ability to get the oil and gas from our reservation because our
practices are quality at a higher level.
We're really not that big on the MMS's concerns because
we're only 3 percent as tribe of what the royalties of MMS has
to worry about on the reservation, but this 3 percent is a 100
percent of our revenues that we get to support our tribe. The
way the government is making all these cuts, we're having to be
self-sufficient in a lot of these areas. We're here to try to
advise the Committee of the issue that we went through and
keeping an open option would be most beneficial to the
government because the government itself is going to be losing
a lot more money they've lost in their past.
We've had some problems with a compliance on our oil and
gas and how do the oil companies owe this money, and they've
done everything they could not to pay out to what they really
actually owed us. We had to file several law cases, and I am
sure you're read our position paper, in order to get some of
this funding back.
Our biggest concern is that we've been affected by other
laws or other Acts that have been passed. For instance, the Oil
Simplification and Fairness Act. It was intended not to affect
the tribes, but in the long run it turned out to affect us. We
had finally developed some kind of a recording process and that
was taken away from us so we had to develop our system in
working with MMS on auditing these oil companies so they could
come and pay us the monies that were due to us.
I want to thank you for giving us the opportunity to
testify. I am not long at words, and I think I just wanted to
be as specific as I could on the reasons why we as the
Jicarilla Apache Tribe wanted to let our concerns be heard.
Thank you.
[The prepared statement of Mr. Vicenti may be found at end
of hearing.]
Mrs. Cubin. Thank you very much for your testimony. I will
begin the round of questions. First I'd like to thank Senator
Wallop for the work that he did in 1993 to help make the nets
receipt sharing more fair. Even though it still costs Wyoming
about $7 million a day, it's much better than it was before.
I wonder, Senator Wallop, could you tell us some of your
experiences that you've had during your years in Congress in
dealing with the MMS, as Chairman of the Energy Committee. This
isn't the first time that you have dealt with MMS on an issue
like this?
Mr. Wallop. No, I was there and as I recall it was Senator
Melcher who was the proud parent of this little beast, and it
was put in place because of the same kind of thing that's going
on now-- that is a series of complex arguments as to the
relative valuation.
I think Ms. Quarterman kind of put her fingers on it when
she was talking about what is the cost to the government, but
every time you apply these costs in one way or another, the
first thing that happens is that they cost the people who are
the beneficiary of the royalties, in our case Wyoming.
What would happen is that the--following a lead that
Congress is quite good at--every time somebody was cross-wired
with the provisions of a rule the first thing they would do is
to put up a board and kind of whack that person with it, but
they'd also change the rule. And every time they changed the
rule then the idea of compliance became more remote and more
complex and more subjective.
And our problem with MMS has been and remains that their
interpretation of things are hugely subjective and now they're
making the claims that these things are criminal conspiracies,
which I just simply do not believe. First of all, anybody who
knows the industry knows that it's pretty hard to get to them
to conspire.
[Laughter.]
Mrs. Cubin. I know that.
Mr. Wallop. But Ms. Quarterman's testimony indicates really
that MMS has no knowledge of the industry and that remains the
source of the disagreement. You have this view somehow or
another that these disputes are all on one side.
You have an indication that somehow or another that
everybody is out to get the government, but the working
knowledge of how royalties are collected is lacking--I mean if
you listened to her anxieties expressed as having to train
marketing agents. Well, they exist. You don't have to train
them. They're there.
As you listen to her talk of government having to store
oil, government is not going to have to store anything. In fact
what they can do is pool relatively inefficient amounts of oil
that are there--and probably be of benefit both to producers
and to the government--as they pool these stripper well
productions and move batches of larger economic size into the
marketplace.
So the list of anxieties that MMS has produced here this
afternoon as to why it is not going to be easy to do RIK, belie
a knowledge of how the industry works. And if they haven't
gotten a knowledge of how the industry works, it is not a
surprise that we have criminal charges being brought and more
litigation. And litigation takes not from their pockets but
from the pockets of the Justice Department, which is all the
rest of us.
So we have a system that is now hugely expensive. I don't
understand why it seems so mysterious that Alberta which is a
highly productive Canadian province has had such a success and
has eliminated so many of the confrontations between the
industry and the government by going to this and increased
their revenues and increased the efficiency, that we can't take
it for granted that there is a means under which we can get
this underway.
Mrs. Cubin. Thank you. I just have one question for you,
Ms. Quarterman. In your testimony you referred to an opinion by
the Department of Justice that was submitted to OMB. Do you
have a copy of that opinion that you could furnish to the
Committee?
Ms. Quarterman. I don't think it was an opinion. It was
part of the regular intergovernmental process of approving
testimony. Everybody in different departments look at it, which
is why we are often late in getting testimony to you through
OMB, and they give their opinions on it--not a formal legal
opinion but their thoughts on it.
Mrs. Cubin. Well this is what your testimony says, ``The
opinion submitted by the Department of Justice on this bill to
the OMB agrees.''
Ms. Quarterman. When I say opinion there, I did not mean a
legal brief.
Mrs. Cubin. My staff contacted OMB yesterday to ask about
that opinion and they were not even aware that there was
anything pending. They said that they had not made an opinion
and that there weren't of anything even pending. So I would
just like you to give me the information, the report, whatever
that opinion was from DOJ, I would just like to see it please.
Ms. Quarterman. I will be happy to get back with OMB for
you. I am not sure that it's something that we ever received a
copy of. I believe that OMB itself put that language into our
testimony, but we can straighten it all out.
Mrs. Cubin. Thank you. Mr Romero-Barcelo, do you have
questions for the panel?
Mr. Romero-Barcelo. First of all, I'd like to thank the
panel for their testimony and the persons here today and thank
you, Sen-
ator, for expressions here. One of the comments you made,
Senator, I want to congratulate you. I think I believe very,
very strongly that simplicity is the enemy of power. There's no
doubt about that. Simple procedures are easier to manage and
definitely undermine the ability of a person in office to do
what they want. There's no doubt about that.
But Senator, there are many significant differences between
the Alberta RIK Program and H.R. 3334. For instance in Canada
the government can choose the oil that it wants to, and under
this bill the Government would not be able to choose. And also
in Alberta the government does not pay the transportation,
whereas in this bill it would.
Those two are basic, basic, substantial differences. Do you
think with those arrangements that Alberta has, where they can
choose their oil and transportation would not be paid by the
government, do you think those amendments would be adequate for
this bill?
Mr. Wallop. I think that in one respect I hear what you are
saying, that there is a significant geographic and demographic
between Alberta and the production of these things in the
country. At some moment in time the government needs to bear
some costs and not be just the harvester of revenues. You spoke
and the chairman spoke of changes that they had in mind, and
those may be some of them, but the fact of it is, that could be
worked out. What can't be worked out now is what is so
obnoxious to my friends in the industry, namely that the
government is now seeking to change the nature of the contract
of which Ms. Quarterman spoke.
When they all went into this, the contract was pretty well
understood as to where valuations took place and what those
costs were, and those are being changed quite subjectively and
quite arbitrarily.
Mr. Romero-Barcelo. By the new rules?
Mr. Wallop. By new rules. And I guess what I am saying is
that if you can work out the problems of which you spoke, and I
don't deny that there are problems within the bill, and neither
has the chairman. Having done that, you significantly lower the
level of confrontation between the government and the
producers, at a great benefit to both.
Mr. Romero-Barcelo. Thank you. Thank you, Senator. Ms.
Quarterman, Senator Hutchison recently included language in the
emergency spending bill prohibiting the Department from issuing
the final rules of valuating oil produced from Federal and
Indian leases, and the Senator argued that the Department had
tried to change the law through the back door of government
regulations. And what authority does the Department have to
issue regulations governing the value of oil and gas production
on Federal and Indian lands?
Ms. Quarterman. The Department has full authority under the
existing laws. Both the Mineral Leasing Act and Lands Act give
the Secretary authority to value oil and gas. That language is
carried over into the lease terms into the contracts. There was
no legislative change or change of a legislative nature that
was being pursued. It was strictly within the bounds of the
Secretarial discretion.
Mr. Romero-Barcelo. Thank you, Ms. Quarterman. What
happened during the posing of the publication of the
Department's Federal Oil Valuation rule? What harm--does that
cause any harm, and if it does, what is the harm?
Ms. Quarterman. I think it causes substantial harm. We were
very close to finalizing that rule, and our estimates are that
it cost the taxpayers $66 million per year. It is something
that I have been working diligently--I and my staff--for the
past two and a half years with industry, holding multiple
workshops at 14 different places--14 different times--5
different states, 5 different Federal Register notices.
We have moved substantially closer we think to the opinions
that were given to us and comments, and we're very close to
going final. So this is a devastating effect.
Mr. Romero-Barcelo. Another question, Mrs. Quarterman.
There are several States that receive royalties from the
Federal oil and gas leases. What has been the reaction of these
States to H.R. 3334?
Ms. Quarterman. As I mentioned in my testimony earlier, we
have heard from some of the larger producing States around the
country: California, Alaska, Texas, Louisiana; all of whom
think that H.R. 3334 in its current form should not proceed,
and they would not be happy if it were entered into their own
states.
Mr. Romero-Barcelo. And they proposed changes to the bill
or they're opposed to the bill?
Ms. Quarterman. I would have to go back to each individual
comment on that. We'd be happy to supply copies for the record
of all the things that we've received from States thus far.
Mr. Romero-Barcelo. Madam Chair, I would ask that they be
submitted.
Mrs. Cubin. Without objection.
[The information may be found at end of hearing.]
Mr. Romero-Barcelo. Thank you, Madam Chair.
Mrs. Cubin. I do want to make just make one statement. CBO
scored the Hutchison Amendment as zero revenue impact, as
opposed to the $66 million. Mr. Thornberry, I know you have to
go to the floor so would you like to take the round of
questions? You can take longer if you want since you can't come
back.
Mr. Thornberry. I appreciate it, Madam Chairman, and
Senator, let me thank you for you appearance. Your testimony
helps remind me, among others, that we are not just dealing
with green eyeshade accounting stuff here, that there are some
principles about central control management versus the market;
and sometimes I find myself getting lost in some of the details
and forgetting some of the bigger picture. And I appreciate
your comments.
Ms. Quarterman, I know that you will not be able to--I am
sure--stay through all of the panels we are going to hear
today, but I hope that maybe some of your folks can because
later on some of the witnesses are going to provide detailed
comments on some of your analysis, and I think it would be
helpful.
I would like for your folks then to come back, and if they
disagree with that analysis--come back and tell us why because
we will--from reading the testimony--I believe we will receive
testimony later--from someone who is in the business of scoring
these sorts of bills that, clarifying three or four
misunderstandings, he can show that the bill gets to a positive
impact on the Treasury rather quickly.
And so, we do have some disagreements, but I would like to
continue to discuss with your folks about how that came come
about.
And let me just ask this question in that regard: If we are
able to change H.R. 3334 in ways so that it receives a positive
score from the Congressional Budget Office which is what
matters up here, would MMS still oppose it?
Ms. Quarterman. Well, first let me go to your first request
which is that we stay around. Miss Tschudy is going to be
available here after I leave. I should warn you in advance that
we received a copy of industry's response to our report late
last evening, and we have not had an opportunity to do any sort
of in-depth reaction to that. We would be happy to provide one
over the course of the next several weeks, if you would like us
to; but to the extent that we can response based on off-the-
cuff comments, we will do that.
Mr. Thornberry. But I really meant just I thought it might
be helpful for your folks to hear the testimony of the other
witnesses. I know you've got a busy schedule, but I just
thought it might be helpful.
Ms. Quarterman. Certainly we want to hear what everyone
else has to say. In terms of being able to respond to some of
the details, I think Debbie will be able to do that. Be kind to
her. This is her first experience here, please.
Mr. Thornberry. She is holding up well.
[Laughter.]
Ms. Quarterman. She is one of our best employees. You're in
luck. As to the second request about whether or not something
could move forward, I would refer you back to my testimony last
week which said very clearly that the Department currently has
the authority to take its royalty-in-kind at its option.
Having said that, let me also draw your attention to my
testimony which offered I hope an olive branch to say that
there is a possibility that royalty-in-kind could make sense in
some instances, and we talked about this last year when I came
before the Committee, we would love it if the Committee were to
become involved in looking at our pilots, and once we have
those complete, talking about what authority, if any, is
necessary to proceed.
Mr. Thornberry. Let me clarify one other brief thing that
kind of related to what the chairman mentioned. Your estimates
on H.R. 3334 are comparing it with what you would expect to
receive under your proposed rule?
Ms. Quarterman. That is incorrect.
Mr. Thornberry. It is under existing law?
Ms. Quarterman. It is under the existing rule making. You
would have to add another----
Mr. Thornberry. Under existing rule making?
Ms. Quarterman. Under existing rules. Sorry.
Mr. Thornberry. Okay. Okay. Because I think there's a
difference between CBO and MMS on how you are scoring both H.R.
3334 and the effect of the moratorium. I am not really
interested in the moratorium, but my only point is that there
is a difference on how these things are being scored out.
Ms. Quarterman. Well, I asked my staff to put together an
analysis of the effects. They are not up-to-date on the rules
that CBO uses, and there are a number, I understand. Over the
years we have learned about many of them. So CBO very well
might have a different analysis.
Mr. Thornberry. Okay. Let me get to one of the substantive
issues that you have raised last time and this time as far as
objections to the bill, and that is the mandatory requirement
that you have to take production even from small marginal wells
in remote areas.
If there were a provision in the bill that would basically
allow either MMS or the State or the lessee to request a buyout
or a prepayment and if you can't agree on how much it is then a
mandatory arbitration to work out the amount--what would your
attitude toward using that mechanism to deal with the marginal
wells or remote wells?
Ms. Quarterman. Well, I would just respond, as I did
earlier, to the fact that we have full authority to take
royalty-in-kind and add that it's difficult to respond to a
hypothetical in a situation like this.
Mr. Thornberry. But I am trying--your first point is the
mandatory royalty-in-kind is your first objection. I am trying
to look for a way to solve your objection by not requiring--and
I am throwing this out--not requiring it to be in-kind in a
State like Wyoming where you have got stripper wells spread out
all across the country. If any of the parties request a buyout
or a prepayment then that would be an option instead of
royalty-in-kind.
As a matter of fact that was, as I understand it, part of
the provisions of the Royalty Simplification and Fairness Act
that we already passed, that you all haven't issued the
regulations for. But isn't that a way to solve your objections
to the mandatory part with stripper wells and marginal wells.
And doesn't that remove really your first objection that you've
always posed to this bill?
Ms. Quarterman. It does not, and Debbie will tell you why.
Ms. Gibbs-Tschudy. Yes, sir. You are correct that the
Royalty Fairness and Simplications Act does contain at section
7 a provision for producers to prepay their royalties for
qualifying marginal properties. We've held three workshops with
States and industry representatives over the last couple of
years to get input into developing regulations to implement
section 7 of RISPA, and based on that feedback we do not
believe that there will many producers that apply for
prepayment for a number of reasons: Number one, section 7
allows government to request additional royalties over and
above the prepayment if we find that the assumptions upon which
we calculated the prepayment changed significantly. Number two,
the States have the absolute veto power over any prepayment
applications and approvals.
We've heard from a number of States that they object to the
prepayment: Number one, because it disrupts their cash flow.
Many states rely on royalty revenues to fund their schools and
a prepayment disrupts that annual cash flow. Number two, many
states would have substantial exposure from prepayment. Of the
qualifying marginal properties, 50 percent of Wyoming's
properties qualify as marginal wells, and 70 percent of
Montana's qualify as marginal properties. So many of them have
felt that provision gives them a great deal of exposure.
Mr. Thornberry. Well, I find it a little bit curious to
argue that you're opposed to prepayment because you're
expecting the money over time, and you don't want it all now at
the present value. That's kind of like the lady that won the
lottery last night. She want's it now, and she'll worry about
the future years, you know, as it comes, and that--I think
she's going to come out okay on that.
[Laughter.]
But let me get back. I am sorry. I'll never pronounce your
last name right. Gibbs----
Ms. Gibbs-Tschudy. Tschudy.
Mr. Thornberry. Tschudy. Ms. Gibbs-Tschudy, if we were to
fix the provisions where they come back and get additional
royalty, and the other objections that producers have now in a
provision that we may include in here to allow buyouts or
prepayments to deal with the marginal wells or the remote
wells, doesn't that really fix this first objection that you
folks have had for H.R. 3334, which is that it's mandatory,
regardless of how much the production?
Ms. Quarterman. I think Debbie's point was that in theory
that would solve the problem but in practicality it does not
because it would not ever be exercised based on what we have
heard so far in trying to write a rule.
Mr. Thornberry. Well, it seems to me maybe we need to write
a better law and you all need to write better rules so that it
fits with the people, but it doesn't seem to me to be something
completely prohibits us from moving ahead.
Let me ask one other----
Mr. Wallop. Mr. Thornberry, can I offer just a quick
observation? One of the things that is troubling to us in
Wyoming who have this number of small producing wells is that
every time you raise royalties you actually reduce the revenue
so they're going to--ultimately go to the States, and the
reason is because you hasten the end of economic viability.
These stripper wells are not hugely prosperous to begin
with, and you start changing the rules and making them
endlessly more complex, as they are now, and the value of
production simply is outrun by the cost of compliance.
Mr. Thornberry. Let me ask briefly, Ms. Quarterman, one of
the statements I think you have made is that--or one of the
objections that's raised in the bill is that it does not allow
to sell or give directly to other agencies so that other
government agencies might be able to utilize this oil or gas,
for example use the gas to heat their schools or hospitals or
prisons.
GSA has told us that they're pretty interested in that, but
you all don't seem very interested in that. Do you have a
position on whether it's a good thing for us to make available
to other government agencies say natural gas that they might be
used in heating Federal facilities?
Ms. Quarterman. I don't believe that we've said that we are
opposed to the bill for that reason but only point out that the
bill as currently constructed does not permit us to do so, and
frankly I am surprised that GSA has told you any such thing
because we have been working closely with them and trying to
give them creative ideas about how they might take gas in
particular in-kind from us.
Mr. Thornberry. So you think it's a good thing?
Ms. Quarterman. Could be.
Mr. Thornberry. Madam Chairman, if I might, one last thing.
One of the interesting problems that I get into in trying to
look at some of you all's comments is that in certain areas we
leave complete discretion to the Secretary to write regulations
on how to deal with situations like who the QMA is going to be
and what the relationship has to be.
And yet we get criticized in the bill when we decide
something, and we get criticized when we don't decide
something, leaving it up to regulations by saying that it's
going to create more auditing and litigation costs. So I kind
of left in a point where you lose either way. Either we decide
something, and you don't like the way we decide, or we leave it
completely to you all to decide, and you don't like that either
because that's going to result in more litigation, according to
you. Don't you think that's going on a little bit here?
Ms. Quarterman. Not at all.
[Laughter.]
You may be surprised to hear that. I don't know what
specific provision you are talking about, where you think the
bill leaves it to us to decide.
Mr. Thornberry. Well, the QMA in particular, where the
Secretary comes up with whatever regulations he sees fit to
govern QMAs and who they may deal with, to make sure their
arm's length transactions. If he doesn't want affiliates
selling to affiliates, he can make a rule doing that. If he
doesn't want affiliates selling to affiliates in California, he
can make a rule dealing with that. It's completely up to him,
and yet that gets criticized.
Ms. Quarterman. Well, what we have been able to ascertain
so far looking at the bill, we believe that you're simply
shifting who we litigate with, from the producer to probably
the QMA.
Mr. Thornberry. Well, Madam Chairman, I would just end by
saying that there are several situations in this bill where we
give discretion to the Secretary and do not intend to overturn
current regulation but wanted to give him maximum flexibility
to do it the way that makes sense, and yet the criticism from
MMS is ``Oh, you can't do that. That just increases
litigation.''
So, sometimes we do seem to be in a lose-lose situation,
but I look forward to continuing to work with their comments
and hopefully continuing to improve the bill. Thank you.
Mrs. Cubin. Thank you. Mr. Pallone--I mean Dooley. Mr.
John.
Mr. John. Just very briefly. First of all, I appreciate the
chairman for calling these hearings. They have been very
educational, and it's been very worthwhile to try to understand
this whole situation because as I have sat here--I think this
is the third or maybe the fourth hearing--I've had people
sitting at that table that not only have supported and opposed
RIK, but have had hands on experience in both of the situations
with some pilot programs, such as Texas that does it at a State
level, and with some other States that do it, and they all have
vastly different stories.
My interest in this has been to try to make it a more fair,
more simple system and get through some of the litigation that
so often clouds not only the State of Louisiana from where I am
from but also the Federal Government.
The crux of the matter it seems with all of the
complications with this bill--and there are quite a few--seems
to be the fiscal impact to the Federal Government. The chart to
my left and to your right, Ms. Quarterman, you ran through it
very quickly. Could you maybe touch on it just a little bit
more about how you come up with these figures, where they've
come and just a little bit more information to guide me because
I think that that it's very, very important that we get down to
the bottom of the costs in these charts because I think RIK is
a great idea and concept.
And I think we need to continue to move forward, but we
need to get down to the bottom of the costs of this bill
because that's going to really make up the minds of a lot of
folks because as you're aware, the State of Louisiana and the
Secretary of DNR is very lukewarm to this bill, and I've been
working with him to try to get down to the bottom of why. So
could you maybe just kind of hit it just a little harder?
Ms. Quarterman. Okay, if you don't mind I will have Ms.
Tschudy go through the elements.
Mr. John. Sure. I know transportation is something that is
very much of concern, and I don't see that word anywhere up
here. So I would like to know where that fits in. I am sorry.
Go ahead.
Ms. Gibbs-Tschudy. Yes, sir. Beginning first with the
revenue losses under royalties which ranges from $182.4 million
to $336.6 million, that's comprised of four components. The
first is transportation. The proposed legislation establishes
the point where the QMA takes delivery of production at the
royalty meter. This is the point upon which volume is
determined for royalty purposes.
Mr. John. Okay, and that's at the well head?
Ms. Gibbs-Tschudy. It's not always. It's sometimes at the
well. It's sometimes at a point remote from the lease, if
approved by the Bureau of Land Management for onshore leases or
offshore Minerals Management for offshore leases.
Under the current regulations, the lessee incurs the costs
of moving production from the lease to the royalty meter.
That's considered gathering. Under the proposed legislation the
government would pay those costs, as a result in the changes to
the definition of transportation and gathering.
In addition, the costs incurred to transport the production
beyond the royalty meter are increased under the proposed
legislation for a number of reasons. The total impact of this
provision is $76 million to $135 million per year.
Mrs. Cubin. Would the gentleman yield for a moment?
Mr. John. Sure.
Mrs. Cubin. As far as the government having to pay
transportation costs, that is not the intent of the bill. If
that's what the words say to MMS we want to work with them to
change that. That is not the intent of the bill. I don't think
that's what it says, but at any rate so.
Mr. John. I appreciate the lady's comments, and that's kind
of why we are having this discussion to make sure that that
it's very clear how we handle transportation costs. So it's
comprised of--the numbers that you have, it comprises 76 to
135, correct?
Ms. Gibbs-Tschudy. Yes, sir. The second component is
marketing. Under the proposed legislation the government would
assume the costs of marketing production. For our analysis we
assumed that the cost of marketing for gas is in the range of
one to three cents per NMBTU, for oil in the range of 7 cents
to 15 cents a barrel. The impact is $17 million to $46 million
per year.
Mr. Thornberry. And if the gentleman would yield briefly.
Mr. John. Sure
Mr. Thornberry. This is another situation where I think
that the bill explicitly says the opposite, that it is not the
intention to have the government pay marketing costs, and if
there's a way to make it clearer we certainly want to look for
a way to do that. But that's one where you flip the whole
amount real quick by, that they allege, by making it clearer.
Ms. Gibbs-Tschudy. The third provision is treating costs.
Under the proposed legislation the definition of marketable
condition is modified from a condition that's acceptable to a
purchaser, as is the current situation, to a condition that is
acceptable by a transporter.
The proposed legislation also changes the definition of
gathering to be to a central accumulation point and eliminates
the term ``and or treatment point.'' Those provisions and
others within the legislation which shifts the cost of treating
production from the lessee to the government. We estimate those
costs to be in the range of $85 million to $178 million per
year.
Mrs. Cubin. In my opinion, if the gentleman will yield.
Mr. John. Yes, ma'am.
Mrs. Cubin. This is most egregious of the misinterpretation
of what the bill actually says. Nowhere do we expect that the
government should pay for the treatment of the oil. I just
can't even understand where in the bill that comes from.
Ms. Gibbs-Tschudy. It comes largely--pardon me.
Mrs. Cubin. Go ahead.
Ms. Gibbs-Tschudy. It comes largely from having the QMA
take delivery at the royalty meter. Frequently treatment occurs
downstream of the royalty meter. So we if we take, though our
QMA, possession at the royalty meter, we are going to have to
incur the costs of treating production downstream of the
royalty meter.
Mrs. Cubin. But the product has to be in marketable
condition. Yes. We do have to go vote, and we'll be right back.
[Recess.]
Mrs. Cubin. Please come to order. Congressman Brady has
some questions for the panel, and Senator Wallop had to leave.
If there are any questions for him we can submit them in
writing and put them in the record later. Mr. Brady.
Mr. Brady. Thank you, Madam Chairman. I appreciate all the
witnesses being here today. And I guess we had visited with Ms.
Quarterman last time about the numbers that were used to arrive
at the $500 million revenue loss projection from last session.
Now it has been revised but clearly appears to be a case where
everything possibly negative about the bill has been expanded
or exaggerated, and everything positive has been minimized or
simply not included.
I guess my question to you is twofold. First, when will we
truly have a revenue impact for this bill from your office that
reflects a true, fair, accurate estimation of this impact?
Secondly, I noticed in the testimony the agency had recently
received management improvement award for management
excellence.
I assume not based on the revenue estimations from last
hearing, but in that the agency had just past a $2 billion mark
in audit and compliance collection from companies that have
underpaid their royalty. My second question would be: Do you
think that oil companies are deciding not to pay their
royalties or is it that the current royalty process is so
convoluted that it is difficult to make a proper royalty
assessment?
And given the estimation from the office so far just on
this bill, I sort of lean toward which answer I think is the
case. Ms. Quarterman?
Ms. Quarterman. Yes. I believe at the first hearing I was
very fearful to say both times that our revenue analysis was an
early estimate, not complete, and at that point we believed
that the effect could be up to as much a half a billion
dollars. What you have here today is a refinement of the
calculations that were just an estimate at the time. Those
calculations show a range up to $373 million, and quite
frankly, they do not include everything that is feasible.
I think you didn't come in at the beginning of my testimony
where I tried to make it perfectly clear that this is a very,
very conservative estimate and that we think the revenue effect
could be much greater, but we went to great lengths to ensure
that we did not over-calculate the effects. We've narrowed the
range of costs. On the point of administrative costs, we did
not include certain costs. There are a number of ways that we
tried to make it as conservative as possible.
Having said that, we are not necessarily saying that this
bill will not have a half a billion dollar impact because there
are still a number of things. There was a chart to the left
here, six different items that we have not completely analyzed,
and some of them I am afraid we will probably never be able to
completely analyze the effect of.
Some of them are surely negative but not easily
ascertainable. Others of them will take more time for us to try
to put our arms around a more legitimate estimate, but once
that is done I would not be surprised if the estimate were to
go back up to a half a billion dollars or more.
Mr. Brady. Actually just to clarify for me, at the last
hearing in the press conference beforehand if I recall you said
that this bill would create a half a billion dollar loss to
American and State taxpayers; and based upon that loss, you
would recommend a veto to the President. Now, of course, we are
seeing completely different numbers. Plus, just in the first
four criteria that you have presented, there is tremendous
dispute whether those are real or imagined.
And I guess my question still stands: When do you think we
really will see, based upon working with members of this
Committee and the authors, a true, fair, accurate appraisal of
this impact?--because that's truly what I think we are trying
to get to, and it sort of reminds me of the Lyndon--LBJ story
from long ago where the school teacher is interviewing for a
job before the school board in Texas. One of the board members
ask him, ``How do you teach the world? Do you teach it round or
do you teach it flat?'' The response is ``I can teach it any
way you want it,'' and in this case I think you are teaching
this bill flat, as negative as it can possibly be, and if we
continue this we will never get I think to a fair assessment
from members of this Committee to make decisions on.
Ms. Quarterman. I would be happy to provide for you both
citations to the record of the last hearing where I stated very
clearly that the effect would be up to a half a billion
dollars.
Mr. Brady. On the second question do you think that the $2
billion mark is because that royalty assessment is so difficult
or because oil companies are deciding simply not to pay?
Ms. Quarterman. Do you mean the $2 billion in compliance?
Mr. Brady. Yes.
Ms. Quarterman. Collections that we have seen so far? I
could not speak for any individual company on why they have not
paid appropriately and on time. I am sure it varies from
company to company.
Mr. Brady. I need to yield back the time, Madam Chairman,
but I would encourage you to sit down with the author and with
members of this Committee and deal with some of the real true
disagreements in this and come up with a revenue impact that we
can base some decisions on. Thank you, Madam Chairman.
Mrs. Cubin. I just have two quick things for you, Ms.
Quarterman. I believe Ms. Tschudy referred to--or maybe it was
you--referred to the governors of certain States thinking that
the prepayment regulation would not be good for them; they
weren't interested in it; wouldn't take part in it or whatever.
Could you furnish those comments to the Subcommittee from the
governors who have expressed those concerns?
Ms. Gibbs-Tschudy. The comments were received from state
representatives that attended the workshops that we held and
we'd be happy to provide you the minutes of those workshops.
Mrs. Cubin. So are there transcripts or just minutes? I
mean would that be referred to in the document that you can
provide to the Committee?
Ms. Gibbs-Tschudy. Yes, they are minutes, not transcripts.
Mrs. Cubin. Okay. Well, we'd appreciate it if you would
give those to us. Our Ranking Member today, Ms. Quarterman,
mentioned the legislation that Congresswoman Maloney and
Congressman Miller filed today. And I wonder if you could tell
this Subcommittee what your position on that piece of
legislation would be?
Ms. Quarterman. Certainly not having seen the piece of
legislation and since it was brought forward today, your staff
person came over and told us shortly before the hearing. I have
not seen it and if there is a hearing on it I am sure the
administration will be happy to supply comments and a position
on it.
Mrs. Cubin. I guess maybe a better way to ask that question
would be--and the bill does implement the rule that--the
legislation would implement the rule that you have come up with
and that would make it law, that would put it in statutorily.
What would be your opinion of that?
Ms. Quarterman. I don't know that that is what the bill
says. I haven't seen----
Mrs. Cubin. Assuming it just implements your rule.
Ms. Quarterman. I can't speak on behalf of the
administration on that matter. As a general matter, I would
recommend that we look very closely at any such legislation.
Mrs. Cubin. Thank you very much. Thank you for your
testimony. I just have one question for you, Mr. Vicenti. You
told the Committee about the difficulties that your tribe has
had with their royalty-in-kind program. I wondered, could part
of the reason be that the Indian Mineral Development Act of
1935 that governs your leases does restrict transportation
allowances? Could that be part of the reason?
Mr. Vicenti. I would love to answer your question, but I'm
not the one that has answers. But, I do have an individual who
could probably answer for--if that's okay?
Mrs. Cubin. Sure. Could you state your name for the record,
please?
Mr. Taradash. Yes. My name is Alan Taradash, and my firm is
general counsel to the Jicarilla Apache tribe.
Mrs. Cubin. Could you spell your name?
Mr. Taradash. Yes. T--like in Thomas--A-R-A-D--like in
Denver--A-S-H.
The Indian Mineral Development Act of 1938 is the Act that
you're referring to. There is no provision in our leases under
that Act for transportation. The reason being that at the time
of the Act's passage, it was contemplated that the sale would
occur at the wellhead, hence, no transportation was necessary
to contemplate. Because of changing market conditions and the
building of the pipelines that did not exist in the current
fashion back in the late 1930's, the transportation allowance
has been created by implication, and that's not the problem
with the complexity that Mr. Vicenti referred to. The royalty-
in-kind program that the tribe had for over twenty years--from
1975 to 1995--was successful because of regulatory prices. And,
the ceiling prices in effect at that time permitted us to enter
in to contracts to get guaranteed ceiling prices. When the
deregulation occurred in pipelines and the elimination of
ceiling prices, because we had the option, we did not suffer
the loss we would have otherwise suffered had we not had the
options. The royalty-in-kind program was successful, but it was
because factors were very different then.
Mrs. Cubin. Thank you. I think the fact that mandatory
royalty-in-kind might not be the best way to go. I think that's
been stated pretty well here today, and I know Mr. Thornberry
and I are willing to look at that and work with MMS to come up
with something that might be acceptable, but anything--I would
think anything that is not taken in royalty-in-kind would have
to be valued at or near the lease. Maybe we can work on some
language or work on something like that.
Thank you. Mr. John, did you have further questions?
Mr. John. No, actually not. I just wanted to thank this
first panel and talk about looking forward to the next panel--
the industry panel--to talk about some of the questions and
some of the statements that were made relative to how these
costs are being developed. I look forward to hearing their
testimony. Thanks.
Ms. Quarterman. Just one other thing. I just wanted to note
that Ms. Tschudy has a plane--she has to leave here at 4:30.
So, she will be available until then.
Mrs. Cubin. Thank you very much. Would you mind leaving the
chart so that we can refer to those and then we'll see that you
get them back afterward? Thank you very much for your testimony
and the answers to the questions. It's very helpful and we
appreciate it. You did a great job for your first time--even
for your second or third. Thanks for being here.
I'd like to call the next panel forward to give their
testimony: Mr. Diemer True of the True Company; Mr. Fred
Hagemeyer, consulting manager, Marathon Oil Company; Bob
Neufeld, vice president, Environmental and Government Relations
for Wyoming Refinery; and Poe Leggette.
I'd like to swear the witnesses.
[Witnesses sworn.]
I have to start by welcoming my friend and former colleague
in the Wyoming legislature, former Wyoming senate president,
Diemer True. We grew up together and went to junior high
school, student council--we've worked together for a long time.
So, I'm delighted to have you here with us today, Mr. True, and
look forward to it. Would you like to begin with your
testimony?
[Laughter.]
You thought I was going to say something else. You're not
gone from that table yet, so I still may.
Mr. True. I was thinking the last time you swore at me, not
swearing me in.
[Laughter.]
Mrs. Cubin. This is better, isn't it?
[Laughter.]
We all like it better.
STATEMENT OF DIEMER TRUE, PARTNER, THE TRUE COMPANY
Mr. True. Well, thank you, Madam Chairman. It's a pleasure
to be here. I am Diemer True, a partner in True Oil Company, an
independent oil and gas producer from Wyoming. I will summarize
my comments today, but I ask that my full written statement,
along with my exhibits, be submitted for the record.
I am here as chairman of IPAA's Land and Royalty Committee
and representing a number of other associations. I submit their
names for the record. We appreciate the opportunity to testify
before you today regarding H.R. 3334. The IPAA, along with
other supporting associations, strongly support the Royalty
Enhancement Act of 1998. The introduction of this bill and your
examination of the Federal royalty rules could not be more
timely. The downturn in world oil prices has exposed America's
half a million low-volume marginal wells to great risk. Many
producers have shut down wells because they are too costly to
operate at current prices. The Royalty Enhancement Act has laid
a foundation from which we can build a permanent remedy to an
uncertain and costly royalty system.
Can the American people make money under a more simple and
certain system? Yes. By greatly reducing the administrative
costs and replacing government accountants and lawyers with
private marketing companies, we can maximize Federal royalties.
I wish I could only be as eloquent in addressing that as our
former Senator, Malcolm Wallop. If H.R. 3334 falls short of
this goal, IPAA stands ready to work with the administration,
Congress, the States, and other trade associations to make
improvements. We believe much of the current criticism of H.R.
3334 stems from MMS's resistance to change, a misinterpretation
of the legislation--which I think you pointed out--and minor
design problems, which can be easily resolved. The MMS needs to
come forward and help resolve the design issues that they will
ultimately face in their pilot programs.
One cannot discuss royalty-in-kind without examining MMS's
oil and gas royalty rulemaking efforts. Even though IPAA
presented the MMS with a cost-effective approach for valuing
oil production at the lease, it intends to issue a final
regulation that assesses a royalty beyond the boundaries of the
law. You could say MMS is impersonating the IRS by trying to
raise--and I use the word in quotes--``taxes''--because royalty
is not taxes--on producers without changing the law. Congress
needs to analyze this new rule for its complexity and to be
sure it is consistent with the contract, which is the oil and
gas lease between oil producers and the Federal Government.
It would appear Congresswoman Maloney agrees with the need
of Congressional action by the mere introduction of her bill
today. Simply put, the MMS is proposing a rule that does not
capture value at the lease. The MMS is ignoring this legal
mandate and is attempting to assess royalties on values
downstream of the lease without full consideration of all the
costs and risks associated with these markets.
We have legally challenged the same arbitrary position in
MMS's gas transportation rule. Parenthetically, the suggestion
that litigation would shift from the producer to the QMA is
remote at best. MMS will hire and supervise the QMA under a
contract. Also, there would be dramatically fewer QMAs than the
thousands and thousands of producers. MMS wants it both ways.
On the one hand, it says that royalty-in-kind will cost the
government money because the Agency will have to pay to market
its production. On the other, it says that industry is required
to pay royalties on the value of the crude after it has been
sent downstream. If MMS recognizes these marketing cost for
itself, why doesn't it recognize it for the industry?
The industry has fully cooperated in MMS's rulemaking and
submitted thousands of pages of comments, much of which has
been ignored. The industry has flowcharted the MMS's complex
and uncertain proposed rulemaking. The chart was labeled
``dungeons and dragons.''
It's to my left. It's on the floor over here.
I might mention that Director Quarterman has countered with
their own proposal, which is here I believe, which has grossly
oversimplified the flowchart. We have drawn the chart--I
believe it's at the bottom down there--which we would suggest
is how the MMS would flowchart the Internal Revenue Code.
Recognizing that my time is about out, the complicated and
litigious debate surrounding valuation leads one to conclude
that the only way to put a final end to the endless confusion
and possible litigation is royalty-in-kind. The administration
must concur because they are proceeding with their pilots. I'm
told the administration supported the advancement of royalty-
in-kind language as part of the Royalty Fairness Law. It
appeared to us at the time they thought legislative language
was needed to do any further experimenting with royalty-in-
kind.
Again, I'd like to thank you for the opportunity to testify
on these important matters today. We look forward to working
with MMS, the States, and the Committee in developing fair and
reasonable oil valuation rules as we implement a successful
royalty-in-kind program.
Thank you Madam Chairman.
[The prepared statement of Mr. True may be found at end of
hearing.]
Mrs. Cubin. Thank you, Mr. True.
Mr. Hagemeyer.
STATEMENT OF FRED HAGEMEYER, COORDINATING MANAGER, MARATHON OIL
COMPANY
Mr. Hagemeyer. Good afternoon, Madam Chairman. It's a
pleasure to be here again for your Committee.
I'm Fred Hagemeyer, coordinating manager of Royalty Affairs
for Marathon Oil Company. I am pleased to appear here today in
support of H.R. 3334 on behalf of the American Petroleum
Institute.
As Representative Thornberry pointed out when he introduced
the Royalty Enhancement Act, it provides a started point to
begin the debate on the royalty-in-kind issue. I want to assure
you of API's willingness to work with the Subcommittee, MMS,
the States, and other interested parties to resolve issues that
may arise during the legislative process. API's written
submission to the Subcommittee in March of this year endorsed
the concept of royalty-in-kind and a progressive measure that
would simplify the royalty payment system for the Federal and
State governments, and the oil and gas industry.
The central advantage of RIK is certainty. Production taken
in-kind and sold in an agreed upon price eliminates the need to
resolve years after the fact the reasonable value of production
at the lease. RIK would also provide Federal and State
governments the flexibility to participate in downstream
markets with the opportunity to enhance their net revenues.
Based on a lot of the comments made regarding gathering and
transportation, I think it's appropriate that I make a few
comments on the gathering and transportation provision of H.R.
3334. To understand these provisions, one must first understand
the role of the delivery point. As set forth in the bill, the
delivery point is the measurement point approved by the
Department of the Interior. The measurement point can be on the
lease, adjacent to the lease, or some distance from the lease.
However, the delivery point, as defined by the bill, is not in
all cases the dividing line between gathering and
transportation.
Gathering has traditionally been on or near the lease, and
the bill does not change that lease concept. Transportation is
generally all other off movement of production--off-lease
movement. We agree that lessees should continue to bear all
costs of gathering royalty production, while the government
should retain responsibility for transportation of royalty oil
and gas.
Looking at the bill's provision for transportation
allowances prior to the delivery point, there are two areas
that we feel need clarification: One would be where
transportation costs are currently allowed by MMS, and another
is subsea transportation. To the extent that the bill may not
clearly provide that the movement of production in both
instances is transportation, then the bill should be amended
accordingly.
H.R. 3334 is consistent with the nondiscrimination
provisions of the OCSLA. It provides that royalty production
shall be transported at rates not exceeding regulated rates or
charges paid by third parties. If an unregulated pipeline
affiliated with the lessee transports royalty production then
the bill's extensive safeguards would ensure that the charge
for transportation of royalty production is commercially
reasonable.
There have been concerns raised about who would pay the
cost of processing and treating royalty gas. Under current law,
processing is deductible, but the cost of treating, or putting
the production into marketable condition, is not. In the
majority of cases, treatment is done by the lessee at or near
the point of production and upstream of the delivery point. So,
we do not believe that the bill would affect any material
change in cost responsibility for treating gas. A gas
processing plant is a facility that utilizes physical processes
to remove elements or compounds from gas. Gas processing plants
are located downstream from the point of production and often
process production originating from one or more fields.
Currently, a lessee can sell its gas outright or enter into
a gas-processing agreement to recover the substances entrained
in the produced gas stream, such as ethane, propane, butane,
and natural gasoline. Under the bill, the QMA, or qualified
marketing agent, would decide whether or not it was
advantageous for the government to process royalty gas.
The final issue I would like to address is the concept of a
qualified marketing agent or QMA. The use of experienced QMAs
instead of the government to market royalty volumes would
provide at least four benefits: First, QMAs could maximize
flexibility by marketing royalty volumes either at the lease
market on in downstream markets.
Second, they offer the opportunity of cost savings in
arranging transportation by aggregating the government's
royalty volumes from individual leases into larger packages.
Also, there is the opportunity of aggregating royalty volumes
with other volumes handled by the marketer.
Third, QMA's and their expertise allow for quick response
to a rapidly changing lease market or downstream market.
And, fourth, the government can use an established and
expert marketing organization rather than creating and training
an MMS government marketing group.
The MMS's concern about QMAs not performing in an open,
competitive, nondiscriminatory manner in transactions with
affiliates is unfounded. The MMS can structure its regulations
and contractual arrangements with its QMAs in such a way that
they have an incentive to maximize revenues realized on their
sales of royalty production.
In closing, I thank you for the opportunity to present
API's position on this important undertaking. We believe that
RIK is not only simpler, it is better; and a comprehensive
royalty-in-kind program deserves careful consideration. API is
interested in working with this Subcommittee, MMS, the States,
and other stakeholders toward achieving a workable solution
that meets the needs of all parties. And as part of this
effort, API welcomes an opportunity to discuss differences
between MMS and the industry concerning provisions in this bill
with a common goal of successfully reinventing an important
government process.
Thank you.
[The prepared statement of Mr. Hagemeyer may be found at
end of hearing.]
Mrs. Cubin. Thank you, Mr. Hagemeyer.
Mr. Neufeld.
STATEMENT OF BOB NEUFELD, VICE PRESIDENT, ENVIRONMENTAL AND
GOVERNMENT RELATIONS, WYOMING REFINING COMPANY
Mr. Neufeld. Thank you, Madam Chairman and members of the
Committee.
My name is Bob Neufeld. I am the vice president of
Environment and Governmental Relations for Wyoming Refining
Company. I am here representing a group of small refiners in
the country who have denominated themselves as the Small
Refiners Coalition. Those other refiners are Calcasieu Refining
Company; Placid Refining Company--Calcasieu and Placid are both
located in the State of Louisiana--Gary-Williams Energy
Corporation, with headquarters in Denver and refining
operations in Oklahoma; and Giant Industries with operations in
New Mexico and headquarters in Arizona.
Madam Chairman, Members of the Committee, I would like to
visit with you on three points with you today. We are in
support of H.R. 3334 and I would like to talk about: Number
one, why it is we feel that H.R. 3334 is necessary? The
egregious and horrible effects, unintended consequences that
have come about by not having certainty in price of oil
valuation. Secondly, how H.R. 3334 addresses those effects. And
third, I would like to talk a little bit about the mistaken
conceptions of how H.R. 3334 is being scored.
Just to review for the Committee, and I went over most of
these points in my testimony before this Committee in the
oversight hearings last September, I will use Wyoming Refining
as an example. We started purchasing royalty oil from the
United States Government in 1987. This is a program authorized
by Congress in 1946 as an amendment to the Mineral Leasing Act
of 1920. Under that program, a lease is chosen for the royalty
oil refiner to take oil from. The oil is delivered from that
lease to the refiner. The producer reports the value to MMS,
and MMS pastes the value in the invoice, sends it to the
refiner, and the refiner pays the invoice on time and in full.
Some time around 1988, MMS started auditing the producer
from our leases without telling us--we didn't know the audit
was going on. In about a year later, they concluded that maybe
the prices the producer was reporting to MMS weren't quite
kosher. But, they didn't tell us that either. They kept taking
the producer's reported prices, which MMS thought were suspect,
put them in our invoices, and sold us the oil. It wasn't until
1995 that we got a demand letter from MMS saying ``We have
underbilled you for the oil you purchased from us. You now owe
us more money for the oil you purchased eight years ago.'' We
didn't quite agree with that, and we are in litigation with the
Minerals Management Service. The problem, though, is that we
have to file a letter of credit in order to continue that
litigation, and it occupies our line of credit that we need to
purchase crude oil that we need to continue operations. We have
approximately a $10 million line of credit, and the letters of
credit that we need to continue to challenge these demand
letters are going to squeeze that line of credit down to a
minimal amount where we will be out of business and not be able
to continue. We will never get our day in court if this process
carries on.
The other refiners in the coalition feel that this is also
an egregious situation, and they have not received their demand
letters yet on leases that they have been purchasing oil from
MMS. However, they have been told that they can be expecting
some very nice Christmas letters this year from the Federal
Government. So, while we are hanging by a thread over the fire,
they are about ready to be strung up also.
Two of things that are particularly bad about this
situation are one, as I said, MMS was aware that the prices
were suspect. Second is by waiting eight years to tell us we
owe them more money for the oil, they denied us the opportunity
to cancel the contract and stop purchasing oil on a basis in
which every barrel purchased became a contingent liability.
On to my second point, Madam Chairman, I'd like to explain
a little bit about how section 12 of the bill works. First of
all, the bill has consolidated the small refiner definitions
that exist for the onshore and the offshore programs for
royalty-in-kind to a level of 120,000 barrels. Next, the bill
has provided that if the Federal Government or the QMA is going
to sell the oil, 40 percent of what would be sold will be
offered to the small refiner at exactly the same price. So,
whether it's sold to the small refiner or whether it's sold to
the offeror or the intended purchaser, the same price is going
to be garnered for the Federal Government. There will be no
price reduction.
That is essentially it. The Secretary of Interior will keep
a list of small refiners and will keep a list of QMAs. The
small refiners will be told who the QMAs are and what type of
oil they're selling. The small refiners will subscribe to the
QMA and say ``I'm interested in what you're selling. Please let
me know when you sell it.'' When a sale is made, the small
refiner gets an opportunity to purchase 40 percent of it.
With respect to the scoring--and I will finish up quickly--
we believe a mistake is made in that the bill says that we get
the oil at the price of the lowest--40 percent of the oil
receiving the lowest successful offers. MMS has said we will
get the oil at the lowest offered prices. Somewhere in there
they have missed the word ``suc-
cessful.'' The offer has to be successful before that is the
price that is imputed to the small refiner sale.
With that I will conclude my remarks and wait for some
questions. Thank you, Madam Chairman.
[The prepared statement of Mr. Neufeld may be found at end
of hearing.]
Mrs. Cubin. Thank you.
Mr. Leggette.
STATEMENT OF POE LEGGETTE, ESQ., JACKSON AND KELLY
Mr. Leggette. Thank you. I'm Poe Leggette--or Leggette--
here on behalf of the IPAA. I have a svelte written statement
and grossly overweight attachments to submit for the record.
But, my oral presentation I hope will be even slimmer than
svelte.
I appreciate the opportunity to be back here today to
address the concern that MMS's proposed crude oil rule, the
dungeon and dragons rule--which, evidently, kept Mr. Tauzin
from reappearing at today's hearing----
[Laughter.]
Mr. Leggette. [continuing] violates several principles of
law governing Federal royalty. And, in the course of doing so,
I will give you a brief glimpse of what life would be like if
there is no H.R. 3334.
Under the current crude oil rule, which was adopted in
1988, a lessee who sells its oil at arm's length pays royalties
based on it gross proceeds from that sale. Oil that is sold not
at arm's length is valued at the higher of the lessee's gross
proceeds received from its affiliate or a value based on
benchmarks. Now to the extent possible, these benchmarks look
to arm's-length sales at the lease as the correct measure of
royalty value. And, if the MMS decides that even an arm's-
length sale has an unreasonably low value because of lessee
misconduct, then it will use those lease-level benchmarks to
make the lessee pay a higher royalty. A net-back method
evaluation, which starts with a downstream price, and revised
to make deductions back to the lease, is used, but only as a
last resort.
Now, the proposed rule, in contrast, treats arm's-length
sales at the lease as essentially unreliable to value non-
arm's-length sales. All non-arm's-length sales and any arm's-
length sales based on lessee misconduct or arm's-length sales
that in MMS's opinion breach the duty to market at no cost to
the lessor, will be valued using downstream prices; a NYMEX
price; an Alaskan North Slope spot price in Los Angeles; spot
market prices in Oklahoma, Texas, Louisiana; or a lessee's
affiliate's downstream resale price. Many, but not all,
transportation costs may be deducted. No other downstream costs
or any other deductions reflecting risks undertaken after the
oil leaves the lease will be allowed on the theory that these
are all marketing costs.
Now, the proposal has several defects in law, and I'll
mention just three. First, royalties are owed only on the value
of production at the lease. By using downstream prices, by
limiting deductions for transportation costs, and by denying
deductions for all other costs and risks, MMS generally will
claim royalty on more than the value at the lease. In effect,
it will unlawfully claim royalty on value added to the oil by
the midstream marketing activities undertaken after the oil
leaves the lease.
Second, the best evidence of the value of oil at the lease
consists of prices paid at arm's length for oil sold at the
lease or at nearby leases. MMS is rejecting the use of the best
evidence in favor of downstream prices, prices in a different
kind of market.
Third, MMS refuses to deduct all value added by midstream
marketing activities on the grounds that Federal lessees have
an implied duty to market crude oil at no cost to the lessor.
However, as noted in my written testimony, this position is in
conflict with the Continental Oil case that Representative
Tauzin read from at the last hearing, which says that duties
don't exist unless they're stated expressly, and the Marathon
Oil case, which says that under the Federal lease gross
proceeds clause, the lessee may deduct both marketing and
transportation costs from the downstream sales price.
IPAA and the Domestic Petroleum Council have invested great
effort in presenting the MMS with revised benchmarks based on
arm's-length sales at the lease. These royalty valuation
procedures are depicted on the chart to my left and are
explained in fuller detail in Attachment 2 to my written
statement. As you can see, just by a visual comparison, IPAA's
proposal has a certain virtue of greater simplicity. But, MMS
has refused to consider this, and its preamble to its most
recent proposal that it issued back in February offered no
explanation for that refusal. Therefore, the Subcommittee may
safely anticipate years of litigation over MMS's proposal.
I thank you for your attention.
[The prepared statement of Mr. Leggette may be found at end
of hearing.]
Mrs. Cubin. Thank you for your testimony.
I'll start the questioning with you, Mr. True. You're not a
lawyer or a lobbyist are you?
Mr. True. No, I'm not.
Mrs. Cubin. So, do think you need to be lawyer or a
lobbyist to be able to help MMS devise a better way to collect
royalties?
Mr. True. Actually, I think as a producer of oil and gas on
Federal lease, I think maybe the independent producer sector of
the group that's interested in this is probably in better
position to offer advice as a practical matter than lobbyists
and lawyers, although, they certainly have their role in all of
this.
Mrs. Cubin. Now, that was a real softball, so you owe me.
[Laughter.]
One of the reasons that MMS objects to mandatory RIK is
because it said there will be revenue losses because oil and
gas markets in the same area will be limited and oversupplied.
What is the situation in Wyoming?
Mr. True. Madam Chairman, that's a good question, and there
are actually three or four different ways to respond to that.
There is an ebb and flow in gas and crude oil markets
domestically. For example, in Wyoming most recently, we had a
situation several years ago where there was an undersupply, and
we were actually receiving bonuses up to $4 a barrel for crude
oil. As you and I have both seen, the Express Pipeline has
brought in Canadian barrels, which we now see as an oversupply
of crude oil in the Rocky Mountain region, and those bonuses
have evaporated.
The reason I cite that as a specific example is I think
royalty-in-kind would better position the Federal Government to
respond as a practical matter to the ebb and flow of over-and
undersupply of crude oil and natural gas markets.
Mrs. Cubin. Thank you. So, you would disagree that--MMS
takes exactly the opposite position that you do on this. They
think that it would hinder competition.
Mr. True. I think quite the contrary. I think the minute
you inject a QMA or some other free enterprise aspect of the
administration of this program, you will see an enhancement of
the value of the royalty as it moves downstream. And, I think
that enhancement will more than offset any incremental costs
that are incurred by the Federal Government in that regard--
more than offset that.
And, again, I think it's the knowledge of the marketplace.
And, I would also like to say that the royalty-in-kind program,
in my opinion, cannot be administered by government employees.
You have to take it into the marketplace to where there's a
profit incentive, and then you're going to maximize the value
of it. And, that's how the RIK is going to accrue additional
revenues to the Federal Government.
Mrs. Cubin. Thank you.
Mr. Hagemeyer, would you address for me the mandatory
aspect of the legislation in front of us. We have a lot of
opinions that it won't work, and there are some reservations
from some States about having RIK be mandatory. Would you just
discuss that for me for a minute.
Mr. Hagemeyer. Sure. I'd be happy to. As we read H.R. 3334,
of course, it is indicated that the Federal Government would
take 100 percent of the oil and gas. There are a few
exceptions, but they're, generally speaking, having to do other
types of leases and so forth. The way we view this, I guess,
is, first of all, starting from a restructuring point of view.
When we started a lot of this discussion, there were a lot of
comments about reinvention, reengineering, and ``let's look at
the process,'' and how would you eliminate parts of the process
which you either can't figure out how to make work or are too
inefficient. So, one of the real benefits when you talk about a
mandatory or an overall comprehensive program is that you, in
essence, eliminate what we've talked about--I've heard here the
valuation issues and the complexity of those, and that's a key
element of those. If you don't go to something that's very
comprehensive, then you will always have the valuation issue.
I'm not sure where the line would be drawn in that situation.
But, without eliminating the process, it's not clear that you
can have some of the significant savings that may be possible.
Going further to that, the concern, in many cases, I hear
about is marginal or small properties, and I know Wyoming has a
lot of those and we're very active there also. You kind of
slice those, in our opinion, in maybe three different ways,
maybe four. First of all, because gas, for the most part, is
pipe connected and as soon as you pipe connect it, a lot of the
issues about the administration and so forth become rather
workable, actually. And then you look at the oil side. Even
with small, marginal properties, there are still a lot of those
that are pipe connected, in many cases they did have
significant production at one time and it's ebbed down, or for
whatever reason their pipe connected into a complex that brings
them into a battery, and that makes it much easier to aggregate
those volumes.
Then you have another segment of that group, which
generally would be trucked, but it's at a high-enough volume.
Even if you're talking about 5 or 10 barrels a day, you can
aggregate enough over a period so that you can justify
transportation or trucking on a regular basis. It's rateability
that matters.
And, then you may have another segment. When you get down
to that last segment where you may have a fractional barrel
kind of situation, then I think that's really the area that you
flow into a Fairness Act, where you would try to eliminate that
issue completely.
Mrs. Cubin. Thank you very much. Mr. Brady?
Mr. Brady. Madam Chairman, thank you. Thank you each for
testifying today. I'll direct this question to Mr. Neufeld but
will invite any of the panelists to respond.
You talked for a moment about section 12 and pointed out
the fundamental difference between lowest offered prices and
lowest successful offered, which I think is a pretty clear and
obvious difference. My question to you is: How different is
that? How fundamentally different are those two concepts? How
would that impact the revenue impacts the Agency has developed
for this bill? And, for all of you: What other areas of
evaluation should we be looking at if we truly want to get to a
fair and accurate revenue estimation in this bill?
Mr. Neufeld. I can only speak for the small refinery aspect
of this, Representative Brady. It seems to me that one other
thing they might be looking at is, although the bill does
eliminate the small refinery administrative fees that would be
coming to the Federal Government, I can't, for the life of me,
figure out why the United States is going to have to incur any
expenses for administering the small refiner program. We will
be, essentially, in the same position as any other purchasers
except that we will be guaranteed the option to purchase a
certain percentage of the royalty oil that the Federal
Government has on hand.
I would like to take this opportunity to point out that
this is a model that is working now. It is a model that, I
believe, the Department of Defense uses in marketing oil from
the Elk Hills Naval Reserve, and it is being done very
successfully. We do not believe it will have any depressive
effect on prices or markets for the oil, even though that has
been suggested, for instance, in the testimony of the city of
Long Beach, and I hesitate to take them on at this point
knowing that they get to testify after I do and will have the
last word. But, our sense is that if you know that there is,
perhaps, 10 thousand barrels per day of oil that's being
offered, and the QMA gets a bid for 2,000 barrels at $18, 2,000
barrels at $17, 2,000 barrels at $16, etc. Somewhere down the
line there's going to be some offers to purchase that oil that
aren't successful. They're just not even on the books. The
bottom 40 percent of the offers will be offered at the average
of those prices--of the successful offers will be offered at
those prices to the small refiners. Now, if we were bid-
ding on the oil and not a small refiner, I sense that a logical
case can be made that you would want to bid as high as you
possibly can so that your bid comes in at the top 60 percent
and that it may have an elevating effect on oil prices.
The marketers in our companies tell me that, as a practical
effect, in situations where they are looking for oil and know
they may not get--if they put in a request and say ``I want to
buy 5,000 barrels a day from you'' and know they may only get
about 3,000, they still price their offers if they're going to
get the whole 5,000 barrels. And, we find the same thing being
true on the other side of our business when we're selling our
refined products to the Federal Government where we offer to
sell 15 million barrels a year, we know we may only get an
order for 7 million barrels a year, but we price it at the 15
million barrels a year.
So, we think the depressing arguments are probably not--may
make some sense in theory, but in practicality, don't come into
play.
Mr. Brady. Great. Thank you. To the other members of the
panel: Are there areas of devaluation by the Agency that we
ought to be looking at to determine a more fair and accurate
impact?
Mr. True. Mr. Brady, I'd like to defer to the witness who's
coming up behind us who has done a great deal of economic
analysis. I'm afraid, at least from my perspective, I would
just add confusion to this subject. Thank you.
Mr. Hagemeyer. Mr. Brady, as far the valuation numbers that
you're asking about, I would like to make a couple of comments
and I think----
Mrs. Cubin. Mr. Hagemeyer, are you a lawyer or a lobbyist?
Mr. Hagemeyer. No.
Mrs. Cubin. I just wondered if that's why Diemer didn't
know the answer.
[Laughter.]
Excuse me.
Mr. Hagemeyer. Maybe he wants to respond.
[Laughter.]
I think, and it's been quoted as maybe misinterpretation or
whatever the case may be, but as we read H.R. 3334--and I think
in particular this is an area that is very important to us all
in gathering and transportation. I guess I heard earlier here
particularly about from the lease to the meter, which, as it is
described in the bill, would be the delivery point. And, as I
tried to point out earlier, the delivery point is not
necessarily the point of demarkation. The key here, though, I
think is the way we see it, gathering as we know and love it
today is related to the movement of product from the lease to
an accumulation point. We don't see that as being materially
different. When we look at where the meters are, in many cases
on shore, they are on the lease or on an adjacent area,
communitized area, and the gathering is before, and that would
not change. When we see offshore there are situations, for
example, where condensate is moved onshore in the gas stream,
is separated onshore, and that's where it's measured. We would
foresee that is where the meter would be. That's where it is
today for condensate. Prior to that, there is a rather
extensive piece of pipe, and that is transportation today. It's
an allowable deduction. We don't see that as being materially
different. As we've read it, we did not see a big change. We
just fundamentally aren't reading it the same way apparently.
Mr. Brady. Thank you. Madam Chairman, thank you very. I'm
just now grateful that I didn't go to junior high with you.
[Laughter.]
It would be hell up all year long.
[Laughter.]
Mrs. Cubin. I used to write notes to Diemer and sign them
``the queen of mean.''
[Laughter.]
Mr. Leggette, could you comment or elaborate for me your
comment that the proposed rule is essentially a new tax on some
producers? I believe I read that in your testimony.
Mr. Leggette. Yes, that's correct. It's--speaking
metaphorically, of course. But basically, what the proposal
here does is to try to tax through the name of a royalty the
profits of midstream marketing activities. Basically, its value
added beyond the lease. It's giving a little bit of deduction,
but basically claiming a royalty share of most of the uplift
you get when you move oil from 150 miles offshore to St. James,
Louisiana. It's in effect a tax.
Mrs. Cubin. Well, it's money out of the pocket of the
producer.
Mr. Leggette. Exactly.
Mrs. Cubin. Mr. Neufeld, there is a difference between this
bill and the bill that's sponsored in the Senate by Senator
Nickles. Could you--you're familiar with that bill. Could you
explain the differences for us.
Mr. Neufeld. The basic differences between the bills have
to do with the way in which the small refiner portion is
calculated and at what point the small refiner has to commit to
purchasing the oil. H.R. 3334 is written in such a way that the
small refiner portion or the option to purchase 40 percent
applies to each sale. It was drafted in that fashion because if
it's written in a way that only over a cumulative period of
time does the small refiner portion need to be offered, or some
volumes have to be offered to the small refiner and some don't,
there's a possibility that the QMA could game the system and
offer choice volumes to favorite customers and dregs of the
barrel to small refiners. And, we simply want to be in on every
sale and have the option to purchase the same oil that everyone
else is purchasing.
Another provision is thats. 1930 would require that the oil
be valued--that 40 percent be set aside before it is sold and
that 60 percent be sold and priced. Once the average price of
that 60 percent is sold, the 40 percent will not only be
offered to the small refiners, but the small refiner will be
required to purchase it without knowing what the price is going
to be. Once you subscribe, you obligate to purchase that
portion of the oil.
H.R. 3334 is quite different. The oil is priced--the entire
amount is priced. And then, you take the lowest price--40
percent of the successful offers----give the small refiner a
look at it, and if he's says yes, he purchases it. If the small
refiner says no, the successful offer or takes the oil home
with him.
Those are the basic differences between the bills. There
are some other administrative differences. We have been working
with the producers and IPAA on that, and we think we have been
come up with language in seven of eight sentences that we have
agreed on and that significantly reduce the administrative
burden on the QMA for the bill.
Mrs. Cubin. Good. Seems like the Senate version, then,
would not change your position that much from what it is right
now: not knowing what you're going to pay until later.
Mr. Neufeld. The Senate version--yes, that's correct,
although, except we won't get the bill eight years later. We
will get the bill 30 days after knowing that we've committed to
the oil. We are, however, committed to working with the IPAA
and the industry to work out our differences. It's a stickier
situation than we thought, but we are confident that we can get
there and be there within a few days.
Mrs. Cubin. Good. Well, I thank the panel for their
testimony and the answers to their questions. Thank you for
being here.
I'd like to call the next panel forward. Mr. Brian McMahon,
Mr. James McCabe, Professor Joseph Kalt, Mr. Ralph DeGennaro,
and Mr. Lin Smith.
[Witnesses sworn.]
Mr. McMahon, we'll ask you to begin the testimony this
afternoon.
Mr. McMahon Actually, I'm going to defer to Mr. McCabe, and
he's going to give our testimony.
Mrs. Cubin. Great.
STATEMENT OF JAMES McCABE, DEPUTY CITY ATTORNEY, CITY OF LONG
BEACH, CALIFORNIA ACCOMPANIED BY M. BRIAN McMAHON, McMAHON AND
SPEIGEL
Mr. McCabe. Madam Chair and members of the Committee, my
name is Jim McCabe, deputy city attorney for the city of Long
Beach. The city of Long Beach is trustee for the State of
California for the purposes of oil produced locally and is
involved in oil matters throughout the State to some degree.
We are here today to speak against H.R.----
Mrs. Cubin. Could I have you pull the microphone up a
little closer?
Mr. McCabe. Sure. We are here today to speak against H.R.
3334. That bill is fatally defective for two primary reasons.
First, it will not yield market value for federally royalty
oil, because the refiners, especially the majors, will not bid
for RIK oil. Second, the bill gives no discretion to the
Secretary of the Interior to withhold RIK oil from sale even
when there are no bids or extremely low bids.
The State of California and the city of Long Beach are in a
unique position to be commenting upon H.R. 3334. We have over
25 years experience in selling royalty-in-kind oil, longer than
any other governmental entity in the country, we believe. We
have learned that major oil companies rarely bid on royalty-in-
kind sales. In over 25 years, only three major oil companies
out of the seven operating in California have ever bid on city
and State royalty oil. These are Texaco, Arco, and Shell. Of
these three, Texaco is the only major that has ever won any
competitive bid. As pub-
licly stated, they will not bid more than the posted price for
any crude oil production.
We have also learned from our long experience with royalty-
in-kind sales is that one essential feature of the State's and
city's royalty-in-kind sales program is the right of the city
and State to cancel royalty-in-kind sales when bids are too
low. Both the city and State have had to exercise that right on
occasion to prevent sales at very low prices.
The city and State have also learned through documents
produced in litigation with the same major oil companies
challenging their posted prices that they frequently pay each
other prices higher than posted prices through complex and
hidden exchanges. We have also discovered that some producers
have been paid prices in excess of posting at the lease,
although these higher prices have not been passed on to the
royalty owners.
It would be a mistake to pass H.R. 3334 without any
successful Federal royalty-in-kind sales. We find it incredible
that no major oil company has made any public submissions to
this Subcommittee either stating its intention to bid
competitively on the royalty-in-kind crude oil or to defend
posted prices, which have been, up until now, the basis for
Federal royalty oil valuation. Independent refiners are also
notable for their absence before the Committee.
What I'm getting at here is that no one is going to come,
in my belief, before the Committee to defend the posted prices.
They have a vast influence on the market, and I don't believe
anyone's going to come to this table to successfully defend the
posted prices before you.
Without any credible assurances that refiners will compete
for Federal royalty oil, it would be folly to pass this
legislation. Although we have objections to some aspects of the
regulations proposed by MMS, we strongly support MMS's general
approach. We do so, principally, because the valuation method
proposed by MMS closely tracks the method used by the major oil
companies in making their internal valuations of crude.
The duty to market is a red herring. Under the proposed MMS
regulations, producers have no duty to aggregate production and
sell it downstream. If producers sell royalty oil at the
wellhead, they pay royalties on the basis of the prices they
receive. For royalty crude oil, which is not sold at arm's
length, for example, if it is sold to an affiliate of the
producer, it is to be valued at the nearest market center less
the cost to transport the crude from the lease to the market
center. This is exactly the same approach used by the Federal
Court in the U.S. v. General Petroleum in valuing Kettleman
Hills crude oil when the oil companies had underpriced it. The
proposed MMS regulation does not require lessees to bear the
transportation costs from the lease to the market centers.
Madam Chair and members of the Committee, Long Beach is
ideally suited to a successful RIK program if there was to be
one. We have a large field amidst many refineries in the middle
of the largest gasoline market in, perhaps, the world: Los
Angeles, Southern California. Yet, our experience with royalty-
in-kind crude sales, which we call sell offs, is that they
clearly do not yield market value--market value as judged by
the internal documents of the oil companies with which we have
dealt.
Mr. McMahon will expand, perhaps, on our chart here, which
I think illustrates this point.
Mr. McMahon We have essentially three prices over the last
six, seven years. One is the posted price of crude oil, which
we receive on a monthly basis. The middle number represents the
sell-off prices that we get for substantial volumes of crude, I
might add--up to 4,000 per day for a year to a year to a half.
And, the third column, the tallest one, represents sales of ANS
crude oil in the same location as where we have the sell offs.
This chart adjusts the quality differences between ANS and the
crude we sell in the Wilmington Oil Field. So, the higher price
is not attributable to fact that it's a better quality. This
has been adjusted using the gravity price differentials in the
posted prices that the major oil companies post in California.
Mr. McCabe. We thank the Subcommittee and certainly would
be willing to answer any questions.
[The prepared statement Mr. McCabe and Mr. McMahon may be
found at end of hearing.]
Mrs. Cubin. Thank yo for your testimony.
Professor Kalt?
STATEMENT OF JOSEPH P. KALT, FORD FOUNDATION PROFESSOR OF
INTERNATIONAL POLITICAL ECONOMY, JOHN F. KENNEDY SCHOOL OF
GOVERNMENT, HARVARD UNIVERSITY
Mr. Kalt. Thank you Madam Chairman and Members of the
Committee. I appreciate the opportunity to appear before you
today. My name is Joe Kalt, I'm the Ford Foundation Professor
of International Political Economy at Harvard University's John
F. Kennedy School of Government. I also work as a senior
economist with the Economics Resource Group, Incorporated.
For the last several years, I have been retained by a
number of oil companies to provide analysis of issues involving
crude oil pricing and royalty payments. I actually began
research into such issues many years ago in the course of my
doctoral thesis and when I worked for the President's Council
of Economic Advisors in the 1970's. My work has allowed me to
acquire extensive data and information concerning the operation
of the various stages of the crude oil production, disposition,
and refining chain, from the lease on downstream to the
refining center.
In the course of my work, I have conducted an extensive
examination of the domestic crude oil industry, in particular,
sales at the lease. As a result of this examination, I have
acquired a large database and related information on arm's-
length transactions occurring at the lease level in U.S. crude
oil fields. This database consists of more than a million
transactions drawn from the early 1990's onward--transactions
that are outright transactions between unrelated third parties,
cash on the barrelhead, not involving buy/sells or exchanges.
This data on outright arm's-length transaction prices produces
results that bear directly on the proposed legislation at issue
in this proceeding.
Specifically, my examination of outright, arm's-length
transactions at the lease has revealed at least four
particularly relevant findings. First, throughout the United
States, there's an active arm's-length market at the lease. The
arm's-length transactions at the lease include substantial
recurring volumes on outright, cash-on-the-barrel-head basis in
trades between unrelated and well-informed buyers and sellers.
At any particular oil field, the observed prices in such
outright, third-party transactions typically span a range that
reflects the influence of highly localized supply and demand
factors pertaining to particular characteristics of particular
crude oils, locational and transactional logistics, and buyers'
and sellers' negotiating strategies and objectives. Moreover,
and of particular relevance here, the range of prices of
outright, third-party transactions typically spans the range of
posted prices that we see applied to particular crude oils and
fields.
Second, transactions at the lease are highly competitive.
The commerce at the lease commonly involves numerous major and
minor integrated and nonintegrated producers on the supply
side, and numerous large and small integrated and independent
refiners, plus a very large number of independent marketers and
brokers, on the buying side. Insinuations and, occasionally,
explicit allegations of some collusive mechanism by which
lease-level crude oil prices are artificially depressed are
wholly inconsistent with the structure of the lease-level trade
in crude oil, and inconsistent with basic anti-trust economics.
Third, some, but not all, crude oil producers move some,
but seldom all, of their crude oil away from the lease via buy/
sell, exchange, or similar contractual mechanisms. Such
transactions typically involve multiple levels of commerce,
with crude oil given up at the lease and offsetting volumes of
another crude oil received at some downstream locale. There is
no evidence that buy/sell and related transactions somehow
systematically hide value that would otherwise accrue at the
lease. These transactions are commonly carried out a posted
prices, plus or minus compensation for locational, quality, and
transactional differences. Yet, as I have noted, posted prices
commonly lie within the range at which willing buyers and
willing sellers are observed to trade crude oil outright at the
lease in cash-on-the-barrelhead transactions. The use of posted
prices to value crude oil and buy/sells and exchanges is
consistent with fair market value at the lease.
Fourth, so-called netback methods for valuing crude oil
typically begin with crude prices at some trading center
distant from the lease and then subtract transportation and
other direct handling charges to arrive at netback values. The
proponents of netback values, such as those contained in the
proposed MMS rulemaking, put them forth as measures of fair
market value at the lease. These netback values are commonly
found to exceed the actual arm's-length prices observed in
outright transactions and to exceed posted prices by on the
order of $.50 to $1 per barrel. However, the gap between
netback prices and observed lease-level prices represents value
added downstream of the wellhead. To an economist, the litmus
test of this lies in the sustained existence and growth of
hundreds of nonintegrated independent marketers who make their
living by buying crude oil at the lease and retrading that
crude oil at downstream locales or in buy/sell-type
transactions. These independent marketers live off of the gap
between netback prices and lease-level prices. They live off
this gap by providing a wide array of downstream middleman
services--from transaction processing and transportation
arrangement to risk bearing and supply aggregation. If these
middlemen did not add value downstream of the lease, the
competition among them would compete the gap away and drive
them out of existence and drive lease-level prices up to
netback levels.
Let me end by noting that it is understandable, of course,
that a royalty owner would like to share in value added
downstream of the lease. Tapping into such value added,
however, would base royalty payments on more than the fair
market value of what the royalty owner brings to the party. I
believe that the evidence is clear that outright, third-party
transactions at the lease provide the best measures of fair
market values of crude oil at the lease. The clear implication
for Federal policy is that if and when the Federal Government
desires to assess the fair market value of its crude oil at the
lease, a well designed, in-kind tendering program will provide
it with a test. Thank you.
[The prepared statement of Mr. Kalt may be found at end of
hearing.]
Mrs. Cubin. Thank you very much.
Mr. DeGennaro?
STATEMENT OF RALPH DEGENNARO, EXECUTIVE DIRECTOR, TAXPAYERS FOR
COMMON SENSE
Mr. DeGennaro. Thank you, Madam Chair. My name is Ralph
DeGennaro. I'm executive director of Taxpayers for Common
Sense. We're a national budget watchdog organization dedicated
to cutting wasteful government spending, subsidies, and tax
breaks, and promoting a balanced budget. We're politically
independent. We seek to reach out to taxpayers of all political
persuasions to work for a government that costs less, makes
more sense, and inspires more trust. Taxpayers for Common Sense
receives no government grants or contracts and is not party to
any royalty litigation.
To put my testimony in context, I would like to underline
two principles that underlie our approach. First, we believe
that oil, gas, and other minerals on public lands belong to the
taxpayers. They are taxpayer assets. Second, that these
taxpayer assets should be disposed of in a way that maximizes
the return to taxpayers of today and tomorrow as well as
minimizes the burden on the government. In accordance with
these principles, Taxpayers for Common Sense opposes H.R. 3334
because the legislation is likely to lose revenue and place new
burdens on the government. These new burdens would contradict
current efforts to reduce the size of government and get the
government out of things it shouldn't be doing.
I think today we've heard a lot of folks beat up on the
bureaucrats and that's pretty common. I think the Minerals
Management Service deserves a big thanks from the American
taxpayer for standing up to those who are trying to gain from
the system, who have a questionable history in the past, and
who are trying to pass legislation that we believe would not
serve the taxpayers.
I think there are two fundamental common sense points here
that need to be underlined. The first is where the burden of
proof should be. The burden of proof should not be on the
taxpayers or the Minerals Management Service to show that H.R.
3334 would lose money. Rather, the burden of proof should be on
industry and supporters of the bill to prove that it would make
money. That has not been done. The second common sense
fundamental point that's been ignored here is that it should be
up to the folks who are being paid--the taxpayers--to decide
how they want to be paid. Just to use common sense, Madam
Chair, if someone owes me ten bucks, I would like to have the
choice of receiving the money in cash or in gasoline. That's
just common sense. Now, it may be that today my car is out of
gas, or it's nearby, or I feel like carrying this thing, and I
feel like being paid in gasoline. Maybe it would be exactly
what I want. Another day maybe I walked, maybe I'm going
somewhere else afterward, I'm not going back to the car, for
whatever reason, I want to be paid the money I'm owed in cash.
We think the taxpayers have that right. We think that MMS's
position seeks to preserve that right, and that's the
fundamental flaw of H.R. 3334, section 3(a), which would
require a mandatory RIK.
Thank you.
[The prepared statement of Mr. DeGennaro may be found at
end of hearing.]
Mrs. Cubin. Thank you.
Mr. Smith?
STATEMENT OF LIN SMITH, MANAGING DIRECTOR, BARENTS GROUP
Mr. Linden Smith. Thank you, Madam Chair. May name is Lin
Smith and I'm managing director of Barents Group LLC. I'm
appearing today on behalf of 17 industry trade associations
listed in my written statement. These associations represent
producers of essentially all of the oil and gas produced in the
U.S.
I'm here today to discuss the Federal revenue effects of
H.R. 3334 and, specifically, to discuss the revenue estimates
prepared by MMS. In background, in April, Barents filed a
Freedom of Information Act request for MMS data to have
information to complete our own scoring analysis of H.R. 3334.
To date, we have received no substantive response from MMS. We
are desirous of having the MMS data as soon as possible and it
will assist in our analysis.
It is first necessary to understand that MMS estimates do
not conform to government scorekeeping conventions. Rather, the
report appears to be a general economic commentary on some
revenue implications of H.R. 3334. Our analysis follows MMS's
framework, but it's important to understand that MMS does not
estimate the effects over the required five-year budget
scorekeeping period. It appears to use constant 1997 dollars
rather than current dollars, and it ignores net receipt sharing
with the States. As you know, the Federal Government keeps half
of onshore revenues, rather than 100 percent as the MMS report
implies.
Regardless of what MMS says about MMS Federal budget
effects, the Congressional Budget Office is responsible for
developing official estimates. We expect that these estimates
will be prepared when H.R. 3334 is reported out of the full
Resources Committee.
A more detailed report provides a point-by-point
substantive review of how MMS believes provisions of the bill
would score. Our review shows that MMS revenue impact is
substantially in error due to numerous analytical flaws,
including misinterpretations of how H.R. 3334 would operate,
errors in economic analysis, and for most of the calculations
presented, insufficient documentation to allow the findings to
be verified or carefully evaluated.
Because there are only few minutes, I will only discuss a
few highlights of our review and use the time to discuss MMS's
largest estimating errors. Our more detailed review of MMS's
analysis, based solely on the MMS information provided to date,
is being submitted for the record.
MMS marketable condition estimate is substantially in
error. MMS principally cites a Purvin and Gertz report as the
basis and source for its estimated $85 million to $178 million
cost per marketable condition. A review of the original report
shows that MMS misinterpreted the analysis. MMS applied gas
treatment costs to 44 percent of all natural gas, when the
Purvin and Gertz figures are only valid for a small fraction of
gas production--6 percent in their original report. Had MMS
contacted the original authors of the report, they would have
learned that corrected data indicate that such costs may apply
to less than 2 percent of natural gas, and most of these costs
are currently deductible under extraordinary cost allowances
already approved by MMS. As result, virtually all of MMS
estimated treatment costs are eliminated.
Marketable condition costs are, however, largely irrelevant
under H.R. 3334. MMS incorrectly asserts that H.R. 3334 would
require MMS to pay for all gas treatment costs. The express
language of H.R. 3334 requires that the lessee bear of placing
royalty oil and royalty gas in merchantable condition at the
delivery point. Even if it had been calculated correctly, MMS
marketable condition cost estimate is not based on the language
of H.R. 3334.
MMS significantly understates the potential for added value
related to crude oil. MMS's own analysis used for estimating
the impact of its proposed oil valuation rule indicates a
potential crude oil uplift of at least $83 million annually. I
can detail that more in questions, if you wish. This is higher
than the $66 million that they publicly announced. This is in
addition to MMS's estimated increase in value of zero to $35
million scored for the bill, which is largely from natural gas.
MMS did not take into account at least one significant
revenue raiser equal to approximately 3 percent of annual
revenues. Our preliminary estimates indicate that first year
revenue increase of $113 million attributable to this revenue
raiser was not considered by MMS.
In conclusion MMS's H.R. 3334 revenue analysis is flawed
technically and substantively. MMS substantially overestimated
the cost and ignored or understated certain positive benefits
or revenue raisers. Where MMS provides a sufficient description
to understand the data sources and methodology, its costs
estimates can be shown to be overstated. Three simple
adjustments to MMS's findings illustrate the magnitude of these
errors. By simply correcting the largest areas, beginning with
the upper end of MMS cost estimate range of $366 million,
subtracting the $.78 million of erroneous marketable condition
cost estimate, adding the $83 million of additional crude oil
uplift, and adding the $113 million of accelerated audit
revenues yields $8 million increased government net reve-
nues. When corrections are made to the MMS's report for other
flaws, even larger net revenue gains will occur.
As I previously testified before the Subcommittee last
September, royalty-in-kind legislation can raise net revenues
for the Federal Government and the States. By making
corrections to MMS's own analysis, it is clear that H.R. 3334
can accomplish that purpose.
Thank you
[The prepared statement of Mr. Smith may be found at end of
hearing.]
Mrs. Cubin. Thank you very much. I want to start with you,
Mr. Smith. Could we get the charts back up there that the MMS
had? What I'd like you to do is just cover, just briefly, the
points where you think those charts are not accurate.
Mr. Linden Smith. Okay. The royalty line--it may be easier
to----
Mrs. Cubin. Those other ones--yes.
Mr. Linden Smith. [continuing] work with some of the other
ones. They're more detailed. That's an overview chart.
Why don't we actually start with the one that's up there
right now, referring to the treating costs. The treating cost
estimate is $85 million to $178 million. I mentioned that in my
oral testimony. It's based on a complete misinterpretation of
the report they cited as relying on, the Purvin & Gertz report.
They misinterpreted the data. And, it is not valid for what
they are trying to do with it, and they are applying it to a
huge quantity of gas when it should be applied to only a small
fraction of gas, and that amount is already covered. The
treatment cost are already covered under their current
extraordinary cost allowance rules.
In addition to that, as I mentioned, on this provision in
particular, the legislation, as we understand it, does not
contemplate the government would bear the cost of treatment.
The next one, I guess, is marketing costs.
Here MMS is estimating a revenue loss of $17 million to $46
million. There would be, indeed, some marketing costs under the
bill because the legislation does contemplate that the
government would compensate QMA's for their marketing
activities. So, there will be some cost. This is one in
particular where we have a difficult time commenting on their
assumption on natural gas marketing costs. What they do is to
cite a number of $.01 to $.03 per million BTU cost, but there's
absolutely no documentation. There's nothing that says where
that came from. So, we can't really comment on any methodology
or anything else other than to say that that range sounds more
on the high side. That's about all I can say about the gas
cost.
On the crude oil cost, it's a little bit more complicated.
What they are doing is saying that the marketing cost should
range between $.07 and $.15 a barrel based on an IPAA study of
marketing costs. What I would say there is that these are
looking at average costs, as they're asking IPAA members how
much on average does it cost to market their production. In
fact, what would happen under the bill is that crude oil would
be added at the margin. That is, a QMA would take quantities of
oil in addition to that which it's already marketing. And then,
marginal cost--that's the cost of trading that additional
barrel--should be much less. That is, they are already going to
have their computers in place, if you will, they'll have their
intellectual capital, their knowledge of markets. And so, if
you give them an additional quantity, we would not expect the
cost of doing that to be equal to their average cost.
The only other piece of information we can look at is an
independent source of oil. That oil marketing cost would be
Alberta. Alberta pays a nickel a barrel Canadian for marketing.
It would be about $.04 a barrel in U.S. dollars. So, we would
suggest that the MMS estimate is significantly on the high
side, but, nevertheless, we do acknowledge that there would be
some marketing costs under the bill.
Let's talk about processing for a moment. This is a
relatively small cost. They estimate $4 million to $8 million
in increased cost due to processing. They're saying that the
Federal Government will bear the cost of the QMA paying
commercial rates as opposed to so-called actual costs, which is
specified calculation that MMS requires. What's wrong with this
estimate is simply that they are assuming a 100 percent
processing cost would bear that commercial rate increase in
value. That is, they're saying today that processing costs are
$38 million. That's the value of the current deduction. What
they do is they say that there will be a 10 to 20 percent
increase in those costs, and 10 to 20 percent of $38 million is
about $4 to $8 million. That's their number. The problem with
that analysis is that it assumes that 100 percent of processing
occurs under nonarm's-length transactions today and would go to
commercial rates. To the extent that there are third party
processing costs today, those would not bear an increase in
cost. They ignored that. Their analysis implicitly assumed that
everything is nonarm's length today and would go to commercial
rates.
In addition to that, they also assume that, in effect, the
QMA has no bargaining power. The QMA is going to control some
fairly large quantities of gas and should be able to bargain
effectively to get lower rates in any event.
Transportation: $76 million to $135 million. Transportation
is, again, a tough one. First of all, their charts assumes
lessee pays for moving production from the lease to the royalty
meter. That's not contemplated largely under the bill. There
may be a few cases where that applies, but, as Mr. Hagemeyer
already went through, this is not what's going to happen in
most cases. So, we're starting out with largely a faulty
premise.
This is also another case where MMS makes some rather
sweeping assumption about increased transportation costs but
provides no documentation on most of their analysis. Where they
do provide some documentation is sort of interesting. They do
say that the bill allows transportation costs for non-royalty
bearing minerals. It's largely water. The bill does not say
that the cost of water transportation is allowed. What is said
is transportation is allowed for royalty oil and royalty gas.
Yet, in their examples building up to their revenue loss, they
cite two properties where they say the government would bear
the cost, and they add that to their revenue loss.
In addition, to that, as Mr. Thornberry pointed out
earlier, one of their examples includes the Menza Platform,
which is the largest source of cost for nonroyalty-bearing cost
on the oil side, and, if fact, Menza's a gas platform. Then,
they cited specific costs per bar-
rel for movement of crude oil from that platform. I don't know
what they were referring to. Maybe they got the wrong name for
the platform. But, it's just not a relevant example. It's
simply incorrect.
In any case, we've got a combination of problems here with
the misinterpretation of the bill, a lack of documentation of
the data, and a mischaracterization or misunderstanding of how
Menza and other fact situations like that would apply.
Those are all comments on the cost side, and certainly
there are additional items on the revenue side as I briefly
went over in my report.
Mrs. Cubin. Thank you very much. Mr. Brady?
Mr. Brady. Thank you, Madam Chairman. I was just going to
ask if you could elaborate on the revenue side of it.
Mr. Linden Smith. Certainly. MMS has one source of revenue
as being potential uplift of zero to $35 million that covers
crude oil and natural gas as the production is moved downstream
of the lease. They largely discount any benefit for uplift on
crude oil. Almost all of the $35 million is for natural gas.
The problem with that is that MMS's proposed oil valuation rule
has in it a statement that the government will get $66 million
a year of additional revenues from using an index pricing
method. Now, we got the underlying data for that under a
Freedom of Information Act request, tried to pour through it.
What we looked at was the calculations where they had the
actual price on which royalties were paid at the lease and they
compared that to the price at a spot market. And, that
difference, with an adjustment for transportation and quality,
when accumulated over all lessees with refineries, accounted
for their $66 million. They did not include any uplift in that
$66 million for lessees without refineries.
Now, how does that compare to what would happen under RIK?
Under RIK legislation, the QMA would take the production at the
lease and would have the opportunity to move the production to
those same markets. The QMA has even more flexibility because
the QMA isn't restricted to just moving it to that index
pricing point but can move it to any point, which achieves the
maximum value for its own benefit and the benefit of the
Federal Government. And so, at a minimum, we start off with
saying that the QMA should at least be able to achieve the $66
million of crude oil uplift that MMS already agrees to, in
effect, would occur under the proposal evaluation rule. In
addition to that, the government would get another $17
million--and again, this is using their data--another $17
million for lessees without refinery capacity, because that
same production would be taken at the lease and also could be
moved downstream or, again, to whatever market maximizes value.
That totals $83 million of uplift, which we believe is there
for crude oil in addition to what MMS scores. And, we do
believe that additional revenues beyond that would be available
because the QMA is not locked into that single downstream
market.
In addition to that, we believe that $113 million of
revenues are available annually. We actually went through it on
a five-year scorekeeping period, where it would be $447 million
over five and about $915 million over 10 years, because the
government is going to be getting all of its revenues that it
now receives with a substantial lag under audit. They'll be
getting all those revenues at the time the production is sold.
That is, today MMS receives audit revenues on average roughly
seven to ten years after the crude or the gas is produced. And,
under the bill, there would be an arm's-length transaction for
value at the lease that occurs at the same time the oil is
produced, so that full value will be received today. In
comparison with a substantial lag in receipts as a result of
long audit delays, all that money will come in up front, and
that will fall in within budget scorekeeping windows as using
the standard CVO conventions for scoring. So that's all a
scorable revenue increase.
Mr. McCabe. Madam Chair, may I add something at this point?
Mrs. Cubin. Certainly.
Mr. McCabe. In think the point that Long Beach would like
to make--one of the points Long Beach would like to make
through its long experience in this area is that aside from the
strictly quantitative aspects--and I can't quantify what I'm
going to say now, but it's very, very important--you set aside
in this bill 40 percent for the independent refiners, and they
are presumably satisfied by this volume, although I can speak
for them. You then are left with a situation in which the major
oil companies--the major refiners--will not bid on this oil.
And, you're dealing with a situation that is by definition no
longer competitive. You've attempted to construct a competitive
marketplace-based system in which the competitors won't come to
the party. I would invite comment by the other panelists if
they truly believe the majors will come and bid against their
own posted prices. We don't believe that will happen.
Mrs. Cubin. You may continue, Mr. Brady.
Mr. Brady. Could you run back the number you were talking
about--the scorable number--as a result of timely receipt of
royalties. You gave figures of what range?
Mr. Linden Smith. The first-year revenue impact would be an
increase of $113 million. The five-year revenue impact would be
$447 million. The ten-year effect would be $915 million. Now,
let me add to this that we do expect to get information from
MMS under our Freedom of Information Act--whenever they choose
to respond to that--that will quantify that with more precision
than we have now. This is based on audit numbers that they
provided in their RIK gas pilot study, and we basically just
adopted that methodology. They are saying there that there is a
3 percent uplift due to audit revenues.
Mr. Brady. Thank you, sir. I was just going to ask Mr.
McCabe, it sounds like from the presentation you run a model
program of RIK. I'm just curious--under Mr. Thornberry's bill,
QMA is given the flexibility to sell the crude oil in a manner
that achieves the highest value for it, whether it's on the
spot or term contracts. Your program, though, is limited to and
mandated an 18-month term contract that had to be firmed up six
months prior to the delivery of it. I also wonder if your
program was at times offering volumes smaller than those needed
by the larger purchasers. And I'm wondering if there are any
years of your program where any of the major oil companies were
prohibited by statute or contract from purchasing the crude
oil.
Mr. McCabe. There--answering the last question first--there
was a period of time when the majors when they were part of the
operators that were taking oil out of our field could not bid.
For a number of years now, those majors, with the exception of
ARCO, have not been part of that consortium taking oil out of
our field. They have been at liberty to bid but still declined
to do so. When I spoke earlier, I spoke not only of our field
but throughout California in California royalty situations.
Mr. Brady. So, the fact that perhaps they needed more
flexibility or they needed larger volumes than you were able to
provide, don't you think that entered into the decisions--
they're not mandated to bid on these contracts, are they?
Mr. McCabe. No, but in order to have a market-based
competitive system, major players need to show up and bid.
They're not going to under the proposed bill.
Mr. Brady. Thank you. Thank you, Madam Chairman.
Mrs. Cubin. Certainly. I'd like to just make a comment, Mr.
McCabe, about your statement that it's like having a party,
inviting people, and nobody will come. The majors won't bid on
the RIK. But, when you think of the quantity of oil that would
come at one-sixth of the oil that would come out of the Gulf,
that is way too huge to not be bid on. It's just too enormous.
The majors would have to bid on that. One-sixth of the oil
coming out of the Gulf that is owned by the United States would
be bigger than that owned by Shell or Texaco or anyone
singularly. So, I think the quantities here might be so much
different that it might not apply.
Mr. McCabe. The majors may end up with that oil. They can
get it through intermediaries and through middlemen. But,
they're not going to come to the party where they're needed to
bid for the oil in question. They will be bidding against their
own posted prices.
Mrs. Cubin. I doubt they would want their refineries to sit
empty because they didn't bid on the oil, but then, somebody
would----
Mr. McCabe. They would, in fact, get the oil, but through
intermediaries and middlemen. The would not bid on the oil.
Mrs. Cubin. Thank you. Dr. Kalt, would you comment for me
on Mr. McMahon's remarks about how California crude prices are
depressed versus that of ANS delivered to Southern California
refineries, and do you think that could be because some of the
majors that are producing ANS crude own refineries in
California?
Mr. Kalt. In my investigations of that situation, several
things stand out. One, ANS crude is not the same as California
crude, and simple gravity scale adjustments don't achieve a
quality parity. There are substantial differences. Crude is not
crude. There's lots of different kinds and different quality
characteristics. Secondly, at least at certain times in the
California situation, what we find is that the capacity that is
used to upgrade refined the low-quality California has tended
to be quite fully utilized. When that capacity gets fully
utilized, the incremental volumes of the crude that drive the
market are going to get a lower price because the capital that
is most effective at using the California crude is fully
utilized, and there's no additional ability to upgrade the
crude oil.
So, when you have a situation like that, when you try to do
comparisons between two physically distinct crude oils--ANS and
California crude oil--it's not going to be surprising that you
will find differences in the value. I think that when one looks
at bid processes that you can see Mr. McCabe talking about,
what one does see is that in the State of California, multiple
parties show up and bid. Mr. McCabe has just noted that
intermediaries or independent marketers show up and bid--the
EOTTs and KOCHs are showing up in California. From a
competitive standpoint, it doesn't matter the name of the party
that shows up. It's supply and demand. If the demand is
registered, then, of course, in supply and demand, it affects
the price. When you put all that together--I read the evidence
considerably differently. With all due respect to the
attorneys, the economist reads it differently compared to the
two attorneys to my right. And, what I see is there is a
pattern that seems quite consistent with what we've seen
elsewhere in the country with other parties who have had RIK
sales. The demand is registered. There are large numbers of
bidders. The bids appear within a range around posted prices.
In the California case, as I understand it, the bids have to be
at the bonus above posted price so you don't get to observe
anything below that. As Mr. McCabe said, during the long
period, the majors were not able to come bid for his oil.
Mrs. Cubin. This chart that Mr. McMahon showed for us--do
remember the differences there? Do you think now that ANS crude
can be sold in Asia--that the difference will be less here?
Mr. Kalt. I'm not sure. I'd have to look at that and study
it from that perspective. Off the top of my head, that doesn't
seem to be the case, though. I don't think you'd necessarily
expect that, no.
Mrs. Cubin. Thank you. Mr. DeGennero, I just wanted to
comment----
Mr. McMahon Could I make a comment? First of all, Mr.
Kalt's study that he presented today does not even purport to
address California. I think that should be clear. He addressed
the midcontinent area, the Gulf coast area. Second, there is no
evidence that, in fact, the processing units that grind up the
heavy crude in California, were full during any of this period
of time. There's always been excess capacity. Number three,
there is no competition in California. Eighty-five percent of
the refining capacity in California is owned by the major oil
companies. And, when you take that amount of demand from the
selloffs from the royalty-in-kind sales, you don't have a
competitive market, by definition.
Mrs. Cubin. Thank you. I wanted to make a comment to Mr.
DeGennero. I completely agree with you that this bill should
not be moved forward if we can't show that it will have a
positive impact on the Treasury. I think that's our obligation,
our responsibility, and nothing will go forward if we can't
prove that beforehand.
Mr. DeGennaro. Thank you.
Mrs. Cubin. I just want to ask you one question. When you--
I'll just be real blunt with you. It seems to me that you have
bought into the rhetoric against RIK, but I'm not sure how much
background or how much information your group has to
substantiate that. For example, I'm not asking you to answer
this question, but do you know how many people are employed and
how may of the taxpayers funds are spend in auditing and
litigation and all those kinds of things. You see, those are
the sort of things where we think we could save money if we
didn't have to go through all those things. Would you like to
comment on that?
Mr. DeGennaro. No, I am not a lawyer or oil industry
lobbyist----
Mrs. Cubin. A lobbyist or a lawyer. Good.
[Laughter.]
Mr. DeGennaro. We do not have the background in the
industry, and obviously there are wiser heads here that speak
to some of the details. I do think there is something to be
said for common sense. If I'm offered the choice between money
or a product, and the question is: Who should be able to decide
how I am paid, I know the answer to that question. And, I don't
think you have to be a lawyer or lobbyist to answer the
question.
Mrs. Cubin. Well, if that were the question I would agree
with you. But, I think the question might be: How much do I owe
you, not whether I owe you.
Mr. DeGennaro. But, the question is the bill--section 3(a)
of the bill reads, ``all royalty and royalty gas accruing to
the United States under any oil and gas lease shall be taken in
kind by the United States.'' That does remove the choice for me
as the taxpayer and my representatives, the MMS.
Mrs. Cubin. And, is that your only reservation about the
bill then?
Mr. DeGennaro. No, and I summarize----
Mrs. Cubin. If we were to not make it mandatory, then would
you continue to have objections to the bill?
Mr. DeGennaro. I summarized my testimony because I believe
in being brief, and it's been a long afternoon already.
Mrs. Cubin. Yes, it has.
Mr. DeGennaro. We did raise some other concerns in the
bill, among them flexibility. It is our feeling that no
legislation is needed at this time. A bill's been proposed and
brought forward, just in the space of this afternoon, and I'd
like to give you credit, Madam Chair and Congressman
Thornberry. A lot of comments have made about things in the
bill that could be changed. I think maybe what we ought to
examine is the option of no legislation at all. Let MMS write
some rules. Let's give it two years to try. They've got some
pilot programs going on. Then, let's see what's necessary.
Mrs. Cubin. I appreciate your opinion.
Mr. DeGennaro. To answer the second question you asked--
well, I'll let that go.
Mrs. Cubin. Okay. Well, I do thank all of you for being
here. I know some of you came a long way, and I really do
appreciate it. We are going to set this bill for a markup, and
hopefully we will have a lot of common ground to work from.
Mr. McCabe. Madam Chair? Just a brief invitation to the
Subcommittee. We have substantial documentation on this
litigation which we think would bear on your question. We would
certainly welcome a request from the Committee to provide those
documents.
Mrs. Cubin. Thank you very much. We appreciate that very
much, and we will take advantage of that.
The Subcommittee is now adjourned.
[Whereupon, at 4:35 p.m., the Subcommittee adjourned
subject to the call of the Chair.]
[Additional material submitted for the record follows.]
Statement of Hon. Malcolm Wallop, Chairman, Frontiers of Freedom
Institute
Madam Chairman, thank you for inviting me to testify at
this hearing on H.R. 3334, a bill to provide certainty, reduce
administrative and compliance burdens with, and streamline and
improve collection of royalties from Federal and OCS oil and
gas leases.
I am Malcolm Wallop and I serve as Chairman of the
Frontiers of Freedom Institute, an independent, non-partisan
public policy research group. I also represented the State of
Wyoming in the U.S. Senate from 1977 until 1995, where I served
on the Senate Energy Committee. As a citizen of Wyoming I have
recently followed the intensifying dispute over oil royalty
valuation with increasing dismay.
It is a troubling paradox of our time that nearly a decade
after the collapse of Communist centrally planned economies the
managerial state not only persists, but flourishes in the
United States of America, where meddlesome and intrusive
regulations by bureaucrats almost defy compliance and restrict
human creativity. Republicans and Democrats proclaim ``the era
of big government is over,'' and the Administration talks about
``reinventing government,'' but overreaching by government
regulators remains the norm at the IRS and throughout the
government.
In the late Roman Empire the clerks and scribes of
officialdom were known as the clerisy, in distinction from the
clergy or priestly sector, that was also economically
unproductive, at least in the material realm. In our day the
clerisy of officialdom in government finds its counterpart--its
mirror image--outside of government in a legion of lawyers and
lobbyists. These forces, contending over how much power cede to
the regulators, do constant battle, in both the legislative and
judicial arenas. The hard reality is that in the name of
fairness, health and safety, no segment of life or the economy
is left private. Worse yet, the only people judged capable of
treating citizens fairly and keeping them safe and healthy is
the modern clerisy, the guardian class on the Potomac.
The endless night of regulatory rulemaking followed by
court battles enriches the clerisy of bureaucrats and lawyers
at the expense of taxpayers and businesspeople. Consumers
always end up bearing the cost of these wealth transfers. A
telling case is the current bitter and costly dispute between
the oil and gas industry and the Minerals Management Service of
the Department of the Interior over the valuation of petroleum
royalties due the Federal and state governments for oil and gas
extracted from public lands. In my home state of Wyoming,
petroleum royalty payments are set aside for education, but the
salaries of MMS auditors and the fees of lawyers reduce the net
revenue available for schools. Regulators thrive on complexity
and specialization. Simple solutions are the natural enemy of
program expansion.
Earlier this year, Frontiers of Freedom Institute
commissioned two well regarded energy economists, Dr. Walter J.
Mead, Professor Emeritus of the University of California at
Santa Barbara, and Dr. Robert Bradley, who heads the Houston
based Institute on Energy Research, to develop a simpler, free
market approach to resolving the oil royalty valuation dispute.
I am pleased to submit the results of their research as part of
my official statement for the record; I do so with confidence
that there are many simple solutions to apparently complex
matters. In an introduction to the Mead-Bradley study, former
Secretary of the Interior William P. Clark joins me in
commending the authors' analysis for consideration by policy-
makers.
Drs. Bradley and Mead begin their work by taking a fresh
look at the entire concept of royalty payments and advocate
sub-soil privatization as the optimal policy objective for the
long term. Their analysis is thoughtful and well reasoned. I
regret that circumstances did not permit either of the authors
to join us for this hearing. Their study traces the evolution
of the valuation controversy since the energy crisis of the
1970's and the attempts by MMS regulators to return to Carter-
era energy market complexity where royalty determination turns
from objective, transaction specific cases into full blown
regulation and subjectivity. The latest MMS rule proposal is
predicated on imputed or synthetic valuation and is imbued with
command-and-control central planning precepts. For the large
majority of Federal lease transactions that the MMS has defined
as non-arm's length, the proposal would determine value at
downstream points, in a different market from where it is
contractually obliged to do so, in effect changing the terms of
the lease contract, and requiring that only some costs could be
netted back to the lease under specific rules.
The authors identify payment of royalty in kind as a
workable compromise to solve today's valuation dispute. Under
such a system, the government would take ownership of the
actual product--oil or natural gas--at the lease and let
qualified marketers utilize their skill to maximize the return
for the government. A similar system in Alberta, Canada enabled
the government to increase oil production, in-
crease royalty payments, significantly reduce the size of
government bureaucracy and eliminate disputes between producers
and the provincial government.
The Frontiers of Freedom Institute is pleased to offer what
we believe is a fresh approach by scholars who are not parties
to the current controversy. Again, Madam Chairman, I thank you
for giving me the opportunity to appear before this Committee.
I would be happy to answer any questions you may have.
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Statement of Cynthia L. Quarterman, Director, Minerals Management
Service
Madam Chairwoman, I am pleased to return before the
Subcommittee today to continue discussing issues related to
royalty in-kind (RIK) programs for Federal oil and gas leases.
First, I would like to offer some perspective on several issues
that surfaced during the Subcommittee March 19, 1998 hearing. I
will then summarize our detailed analysis of H.R. 3334, which
we provided on April 30.
I think it is important to recognize how far we have come
in a short time in royalty management by providing some
historical background on the reasons for the creation of the
Minerals Management Service (MMS). As you know, MMS was created
some 16 years ago. Prior to that time, the Department of the
Interior (DOI) was repeatedly criticized for mismanaging the
royalty program, because of its failure to collect potential
underpayments of hundreds of millions of dollars in royalties
every year. An independent Commission on Fiscal Accountability
of the Nation's Energy Resources (Linowes Commission) was
formed to address those allegations. The Linowes Commission
recommended creation of an independent royalty and minerals
management agency to ensure effective accounting, production
verification, royalty collection and enforcement. Accordingly,
MMS was established and has since resolved all the issues
identified by the Linowes Commission. In addition, along the
way, MMS's royalty management program has accumulated an
enviable array of awards and commendations, including The
President's Council on Management Improvement Award for
management excellence. Just this past month MMS reached the $2
billion mark in audit and compliance collections from companies
who have underpaid their royalties.
It is necessary to refer to this historical context because
at the time of MMS's creation, the Linowes Commission urged
that the ``oil and gas industry should carry out its
obligation, as lessee, to pay royalties in full and on time.''
This statement goes to the very heart of our concern with this
Bill, which is that it disregards the Commission's
recommendation--or more pointedly, its admonition--by forgiving
the oil and gas industry of its lease obligations to pay
royalties in full and on time. By relieving the industry of
their long-established obligations and denying the public of
its rights under the lease, this legislation will return us to
the days of when the public was not assured of getting fair
market value for its mineral resources.
To fully understand the current debate, I believe that we
must look back at the original bargain struck between the
United States, as custodian of the public's lands, and the oil
and gas industry, as lessee. In that bargain, the United States
entrusts oil and gas lessees with the right to explore for,
develop, and produce minerals from Federal lands. The lessee
benefits by retaining most of the mineral proceeds from those
lands. In exchange, the lessee agrees to care for those lands
and return to the United States a small portion of the proceeds
in value or in-kind, whichever the government prefers. In
addition, the lessee agrees contractually to be bound by the
government's reasonable determination of what that value is. To
eliminate the government's choice in royalties would deny the
public its rights under the lease and, ultimately, return less
than the fair value due and owing.
It is instructive to look at an illustration of why that
happens under this Bill:
First, a 100 percent royalty in-kind program forces the
government to accept oil and gas in those circumstances where
everyone agrees we would lose money compared to accepting
royalties in value. In accordance with the Administration's
initiatives to run government more like a business, MMS has
begun to identify the conditions under which it is prudent from
a financial or business standpoint to exercise its lease
contractual rights to take royalties in-kind. The Texas General
Land Office recently informed the Subcommittee that it follows
the same policy. This is simply the most responsible and
businesslike way to proceed. To do otherwise would abdicate our
stewardship responsibilities over the public's land. Where it
is not prudent to take royalties in-kind, we will simply
continue to require lessees to honor their obligations to pay
royalties in-value pursuant to their lease contracts with the
United States.
Second, this legislation relies on an unproven premise that
aggregating crude oil volumes taken as in-kind royalty would
enhance royalty revenues, including revenues from leases with
de minimis production. Contrary to that premise, MMS has been
told repeatedly by many producers that aggregating crude oil
does not significantly enhance value, and we concur in that
assessment. As Phillip Hawk of the EOTT Energy Corporation
testified last month, crude oil value depends on a long list of
characteristics related to individual properties. It is
precisely such an assessment that makes us move cautiously when
choosing which properties to include in--and which to exclude
from--an oil royalty in-kind pilot. Aggregation of de minimis
volumes could theoretically increase value, but the
administrative costs of taking small volumes from numerous
leases would almost certainly more than offset any revenue
enhancement. That is probably why the Texas General Land Office
does not take royalties in-kind from wells producing less than
10 barrels per day and why the Alberta crude oil RIK program
requires the producer to bear those administrative costs. Most
of our onshore Federal oil leases are de minimis leases, and
most also have low royalty rates. Therefore, we may be forced
to take one half a barrel or less of royalty oil per day from
thousands of leases at large administrative costs. Since MMS or
its marketer would be only aggregating 10 percent or less of
the volumes taken from these de minimis leases, MMS necessarily
must do at least 10 times the cost per unit to realize the same
revenues as the producers. This is simply not cost effective.
In these situations, it would be virtually impossible to obtain
a revenue gain over what the producer, who owns and transports
over 90 percent of the production, obtains. The risks to
royalty revenue and the costs that reduced oil and gas revenue
to the government will also reduce annual state revenue sharing
of oil and gas revenues. H.R. 3334 shifts to the taxpayer
extend to all Federal oil and gas producing areas.
Last week, we provided the Subcommittee a detailed analysis
of the bill. Before answering any questions, I would like to
briefly summarize our conclusions concerning the bill.
MMS ANALYSIS OF H.R. 3334
In summary, this Bill would drastically reduce the options
and legal rights of the Federal Government as mineral lessor
and hinder the government in its duty to assure a fair return
to the public for its oil and gas resources.
Ambiguities and vagueness in many areas of the Bill make it
difficult to discern exactly how certain provisions operate.
Certain provisions of the Bill, such as those addressing
transportation cost reimbursements, will maximize costs to the
government and reduce royalty revenues commensurately. We
estimate that the government's costs of just storing processing
and transporting the oil and natural gas to the buyer, as
proposed in the Bill and which are now the responsibility of
the lessee, are at a minimum in the hundreds of millions of
dollars per year, while the administrative cost savings are
less than $8 million per year in the first 8\1/2\ years. Our
estimates for potential revenue effects vary from negative
numbers to tens of millions in theoretically possible gains.
However, any such potential revenue gains can be realized
without this legislation. MMS's existing right to take
royalties in-kind and our capability to do so--being developed
through our RIK pilot programs--allows us to realize all of the
possible revenue gains for the taxpayer without the costs
associated with this legislation, and without revenue losses
from areas where RIK is not a feasible option. Thus, as I
testified earlier, H.R. 3334 will have a substantial negative
annual cost impact on the Treasury and will not enhance revenue
compared to current statutory authority.
It is also important to note that our analysis of the costs
associated with this Bill are very conservative and do not
include a number of clearly negative provisions that we could
not quantify in the time available. In contrast, the
administrative cost savings figures used in the analysis are
very liberal because they do not take into account the costs
necessary to startup and implement the royalty in-kind
provisions of the Bill. Additionally, the costs of contracting,
overseeing, and auditing qualified marketing agents (QMA) under
this Bill could easily wipe out the $8 million in cost savings.
Another $6.2 million in revenues could also be lost through the
net receipts sharing provisions of the bill. Since the Bill
does not explicitly rule out potential QMA conflicts of
interest situations, our auditing and litigation costs are
likely to increase. The opinion submitted by the Department of
Justice (DOJ) on this Bill to the Office of Management and
Budget (OMB) agrees. Finally, the potential revenue
enhancements figures used in the analysis are extremely
generous because we assume ideal conditions for this royalty
in-kind program despite provisions of the Bill which provide
the opposite.
The following summarizes the major issues that concern the
Department with respect to H.R. 3334.
1. Mandatory Royalty in Kind
The Bill requires the government to take royalty volumes of
both oil and gas in-kind for all Federal leases onshore and
offshore. Requiring RIK for all Federal oil and gas production
virtually guarantees revenue losses because:
<bullet> The value of the current option of taking in-kind and
taking in-value in areas where each are economically justified
is eliminated.
<bullet> Taking de minimis volumes of production in remote
areas is administratively inefficient and will be a revenue
loser compared to the current system.
<bullet> Oil and gas markets in some regions are limited and
oversupplied. Adding another major player to such markets
without infrastructure will not add value.
2. Imposition of a Rigid Statutory System
H.R. 3334 would impose a rigid ``one size fits all'' statutory
scheme that eliminates the ability of the executive branch to use its
existing RIK authority to develop jointly with affected parties a
flexible system that works best for individual areas/situations. Just a
few examples of the Bill's inflexibility are:
<bullet> Sales would only be made by marketing agents,
precluding direct sales to government facilities without
marketing agent involvement and costs.
<bullet> No provisions exist to address when no bids or
unacceptable bids are submitted.
<bullet> State in-kind programs for just the State's share are
not allowed.
3. Technical Provisions
H.R. 3334 contains a variety of technical requirements for
gathering, transportation, treatment, and processing that in sum
transfer obligations to the government and increase many of the costs
and responsibilities historically borne by producers.
a. Marketable condition
The Bill would replace the current requirement for lessees to
place production in a condition acceptable to purchasers with a
requirement for acceptance by transporters. This is a
significantly less stringent condition that would now require
the U.S. to begin paying for sweetening, treating, and
conditioning services. The initial transporter is often owned
by the lessee or its affiliate. Thus the Bill creates the
potential for the lessee to self-define marketable condition.
b. Gathering
Although the distinction between gathering and transportation
in the Bill is confusing, the overall effect will be to move
the dividing line between gathering and transportation closer
to the wellhead, thereby shifting costs from producers to the
government. It appears that under the Bill all movement is
transportation (i.e., costs borne by the government) except
movement of bulk, unseparated production on the ``lease
premises.'' Approximately 25 percent of offshore and 50 percent
of onshore crude oil movement and 10 percent of offshore and 25
percent of onshore natural gas movement upstream of the royalty
meter now paid for by lessees would be paid for by the U.S.
c. Transportation
The Bill would require the U.S. to begin paying for
transportation of non-royalty-bearing substances (e.g., water)
in bulk production volumes moved from the lease. Movement of
bulk production downstream of the lease is a growing phenomenon
that would require the U.S. to assume an increasingly large
cost burden compared to today. Further, the rates that the U.S.
would be required to pay for transportation under the Bill
would also increase dramatically compared to those currently
paid by lessees. The U.S. would in some cases be required by
the Bill to pay the highest rates charged to third parties.
d. Processing/Treating
Taken together with a redefined ``marketable condition,'' the
Bill would shift to the government much of the cost of
cleaning, decontaminating, and other field services. Further,
the substantial amount of production currently processed by
lessee's affiliates at actual (relatively low) costs would be
processed at much higher, commercial rates under the Bill.
e. Marketing
All costs to market oil and gas production would be assumed by
the U.S. under the Bill, whereas, under the current royalty
system, these costs--which are substantial--are now borne by
lessees. Ironically, the Bill would actually create marketing
costs (to be borne by the U.S.) in many cases where there now
are currently no such costs (e.g., for the substantial volumes
of crude oil production simply moved from major producers to
their own refineries).
4. Negative Revenue Impacts
H.R. 3334 will have a substantial negative annual impact on the
Treasury. Specifically, we estimate increases in costs to the U.S. at a
minimum of between $183 million and $374 million per year, depending on
assumptions used. This estimate is comprised of the following items,
summarized in the charts you see before you:
1. Transportation: Government costs would increase due to the
assumption of payment for gathering, and to increases in the price paid
for transportation. The total increased cost to the U.S. ranges from
$76 to $135 million annually.
2. Processing: Costs will increase some $4 to $8 million annually
due to payment of higher commercial rates rather than the lessee's
actual costs.
3. Treatment: Government costs will increase due to the assumption
of field treatment processes beyond the delivery point, estimated at
$85 to $178 million annually.
4. Marketing: Costs will increase some $17 to $46 million per year
due to government assumption of marketing costs.
5. Other: The costs of eliminating the small refiner administrative
fee and the net receipt sharing for states who participate in the RIK
program will range from $0.8 to $7.2 million annually.
These cost increases are offset by only a maximum of $7.3 million
in annual administrative savings and $35 million in maximum theoretical
annual revenue uplift due to RIK implementation. Again, we can realize
any revenue uplift from RIK without this legislation, and its
substantial costs, under current authorities, using a more deliberate
approach.
Other provisions of the Bill having negative revenue impacts which
we could not quantify because of the many unknowns associated with them
include:
<bullet> The requirement that the government must offer 40
percent of royalty oil to eligible small refiners at the lowest
prices prohibits the government from receiving the highest and
best price for 40 percent of royalty oil. This requirement
alone almost completely undercuts the assumption on which the
Bill's proponents' claims of increased revenues are founded.
<bullet> Increased litigation costs. The Department of Justice
believes that H.R. 3334 may impose serious new litigation
burdens on it.
<bullet> Imbalance provisions that are biased heavily in favor
of the producer.
<bullet> Price manipulation between a QMA and its affiliate.
CONCLUSION
From the above comments, it should be clear our position on the
Bill remains unchanged from our 3/19/98 hearing statement. You have
also heard concerns about this legislation expressed by officials from
the States of Texas and New Mexico. DOI staff and I have also heard
negative comments from officials in Louisiana, California and Alaska.
We believe the time has come to agree to a more productive course in
our mutual desire to improve royalty management systems and to
experiment with royalty-in-kind options.
In this spirit, I would like to reiterate our request that people
directly involved in oil and gas production, marketing, and accounting,
rather than lobbyists or lawyers, both advise MMS on its pilots and
offer independent opinions to the Subcommittee as we all explore how we
can best use the RIK option to everyone's advantage.
This concludes my prepared remarks. I would be pleased to answer
any questions you may have.
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Statement of Diemer True, Partner of the True Companies and Chairman of
Independent Petroleum Association of America's (IPAA), Land and Royalty
Committee
Madam Chairman:
I am Diemer True, a partner in True Oil Company, an
independent oil and gas producer from the state of Wyoming. In
1997 True Oil Company produced approximately 130,000 Barrels of
Oil Equivalent (BOE) of Federal production.
I am here today as Chairman of IPAA's Land and Royalty
Committee and the Wyoming Independent Petroleum Association.
IPAA is a national trade association representing over
8,000 of America's independent oil and natural gas exploration
and production companies. IPAA members operate in all 33 states
that have oil and natural gas production. They drill about 85
percent of all wells in the United States (including Alaska),
produce about 37 percent of the domestic crude oil and are
responsible for about 64 percent of the natural gas production.
Madam Chairman and members of the Committee, we appreciate
the opportunity to testify before you today regarding H.R.
3334, the Royalty Enhancement Act. IPAA's support for the
Royalty Enhancement Act of 1998 should come as no surprise to
the Committee. Throughout the 104th and 105th Congress,
independent oil and gas producers have been strong advocates
for designing a mandatory royalty in-kind system that will be a
win-win for the American public. We want a fair system for
all--taxpayers, the Federal Government and industry.
Madam Chairman, and members of the Committee, the
introduction of this bill and your examination of the Federal
royalty process could not be more timely. The downturn in world
oil prices has exposed America's half-a-million low volume
marginal wells to great risk. Many producers have shut down
wells because they are too costly to operate at current prices.
Some are reducing their exploration and production budgets for
the remainder of the year. Others will have to stop operating
if prices don't recover soon.
If we are to maintain a viable domestic industry, we need
Federal regulations and policies that encourage production from
Federal lands. As prices fall, the impact of regulatory costs
becomes a greater and greater burden. As an independent
producer of Federal production, I am facing shrinking returns
on investment. It is not in the best interest of the American
people to have scarce investment dollars being allocated to
royalty compliance as a priority to the detriment of
exploration and development. Royalty in-kind allows royalty
regulatory costs to be redirected to exploration and production
investment in America's energy future. Producers can invest
these savings into sustaining production for future
generations. The government can invest its savings into
creating greater revenue for the American public.
The Royalty Enhancement Act has laid a foundation from
which we can build a permanent remedy to a problem that has
haunted America's royalty collection system for decades--
uncertainty accompanied by high regulatory compliance costs.
Under royalty in-kind, the government gets one barrel for every
eight we produce (assuming a 1/8th royalty). This would be one
mcf out of every eight mcf's and generally offshore one Bbl or
mcf out of every six. It can't get any more certain than this.
Under-deliveries can be easily detected and resolved in a
timely fashion.
Can the American people make money under a more simple and
certain system? Yes, by greatly reducing administrative costs
and replacing government accountants and lawyers with private
marketing companies who can maximize Federal revenues. If H.R.
3334 falls short of this goal, IPAA stands ready to work with
the Administration, Congress, states, and other trade
associations to make improvements to this legislation. We
believe much of the current criticism of H.R. 3334 stems from
either a misinterpretation of the legislation or minor design
problems which can be easily resolved.
Although some may not believe royalty in-kind is the
solution, we must remember that the Federal Government was the
first to believe that it was the answer. Royalty in-kind was
introduced as part of the Clinton Administration's Reinventing
Government project in 1992. This program concluded that royalty
in kind could streamline royalty collections and enhance
revenues. The Administration cannot now deny that royalty in-
kind can accomplish this goal given that it is proposing future
pilot projects.
Nevertheless, if royalty in-kind is being advanced via
mandatory legislation or pilot programs, the operational
aspects of a royalty in-kind program remain the same. We
encourage MMS to come to the table and suggest workable
improvements consistent with lease terms to the royalty in-kind
program outlined in H.R. 3334. We sincerely want to work toward
a fair solution, and not battle rhetortic in the media.
Most of the criticism from MMS focuses on how costs will be
distributed in an in-kind environment. Mr. Linden Smith
(Barents Group), will provide testimony on the validity of
these claims. However, MMS faces these same design issues
(transportation, marketing, processing, etc.) in its own pilot
programs, plus statutory and regulatory barriers that are
resolved by H.R. 3334. It is MMS' duty to the Congress and the
American public to come forward and help resolve these design
issues, so any future royalty in-kind program will be
successful. Too much of the taxpayers' money has been invested
in royalty in-kind to walk away and not attempt to build a
successful program. Again, we want to engage in meaningful and
thoughtful discussions that move toward resolution of the
issues.
MMS' Valuation Rulemakings
Madam Chairman, and members of the Committee, one cannot
discuss royalty in-kind without examining MMS' oil and gas
royalty rulemaking efforts. Over the last couple of weeks, a
lot of public attention has been drawn to MMS' proposed
rulemaking for oil royalties. In this debate, a great deal of
misinformation has been circulated by defenders of a complex
system that would lead us down a road filled with uncertainty,
costly disputes and litigation.
Even though we have presented MMS with a fair and cost-
effective approach for valuing oil production, it intends to
issue a final regulation which captures downstream values at no
cost to the government by creating a very complex and
burdensome system. This could not come at a worse time for
America's oil and gas producers and for our country's energy
security. We strongly recommend that Congress intervene to
ensure MMS promulgates rules that are well reasoned and are
consistent with the law.
Madam Chairman, I would like to set the record straight
concerning the role and views of IPAA, its members, and other
trade associations and their members in MMS' oil royalty
rulemaking process:
1. Is MMS proposing an oil royalty rule which captures
value at the lease?
No. This is why Congress must intervene. The oil and gas
lease and the law, require royalties to be paid on the value of
production removed or sold from the lease. The MMS is ignoring
this legal mandate and is attempting to assess royalties on
values downstream of the lease without full consideration of
all the costs and risks associated with these markets. Simply
put, it proposes to assess royalties on values in the wrong
markets.
The agency is trying to move the starting point for royalty
valuation as far from the leases as it can. MMS might argue
that after ``netback'' (allowing costs to be deducted), the
result ends up with a value at the lease. Nothing could be
further from the truth. For example, MMS disregards the fact
that there are costs associated with marketing. By not
recognizing these costs, MMS clearly is attempting to collect
royalties on more than the value of oil and gas at the lease.
MMS wants it both ways: On the one hand, it says royalty
in-kind will cost the government money because the agency will
have to pay to market the production. On the other, it says
industry is required to pay royalties on the value of crude
after it has been sent downstream. If MMS recognizes these
marketing costs for itself, why doesn't it recognize it for
industry?
2. Does the law give MMS the authority to disregard these
marketing costs?
No! We believe the law and the contracts are on our side.
Congress intended for value to be set at the lease. If you move
to a market downstream from the lease market, marketing costs
will be incurred.
Independent producers take this issue, on the deductibility
of costs, very seriously--so seriously, in fact, that we have
filed a lawsuit against the DOI challenging the validity of the
new natural gas transportation regulation. The gas rule went
into effect February 1st. IPAA filed the lawsuit in D.C.
District Court on March 2 following a unanimous vote in favor
of the complaint by the association's Board of Governors.
Why are we suing DOI? Because we believe the rule is
illegal. It threatens future gas production. It will discourage
drilling on Federal lands because it forces producers to market
gas downstream of the lease at no cost to the government. That
drives up the cost of the gas and means producers end up paying
an inflated royalty that is greater than what is due under the
lease contract. We cannot overstate this fact--what the Federal
Government is asking us to do is in violation of the terms of
the lease contract. And now, MMS has repeated this outrage by
extending it to oil. I refer you to my letter written to the
Oil Daily on April 17, 1998, regarding our views of the duty to
market issue which is part of Exhibit 3.
If Congress doesn't intervene, then the American public
loses, because the gas and oil rules will generate years and
years of costly litigation on both sides. MMS was headed to a
final rulemaking this June. Fortunately, Congress blocked its
efforts and is going to fully examine the extent to which MMS
has usurped the legislative role. You could say MMS is
impersonating the Internal Revenue Service, by trying to raise
``taxes'' on producers without changing the law, but through
more complicated regulations on the value of crude oil.
Congress determines taxes, not the IRS. MMS should follow the
same rules.
3. Has the industry thwarted MMS' efforts to change its oil
valuation rules?
Again, the answer is no. Thousands and thousands of pages
of comments have been provided to MMS by all sectors of the
industry. The MMS decided to write a new valuation rule based
on alleged problems with the current rule. Independent
producers also supported regulatory changes. The MMS' response
to our dedicating hundreds of hours to develop new and
reasonable valuation methods has been a proposal that makes it
harder for independents to determine the appropriate royalty
value with certainty. The rule is so complex that independents
are referring to it as the ``auditor employment act.''
During the March 19th hearing, an IPAA witness introduced a
flowchart displaying the complexity and uncertainty associated
with MMS' rulemaking proposal (known as the ``Dungeons and
Dragons'' chart). Director Quarterman has since sent you a
letter dated April 30, 1998, stating that our chart was highly
distorted (See Exhibit 1). Yet she fails to point out a single
error in the industry chart.
As an alternative, MMS offered a simplistic chart depicting
its proposed rulemaking. We must respectfully point out that
producers will not be able to resort to such simplistic
solutions when filing their royalty reports, should the
proposed regulation be made final in its current form. This
oversimplification is much like the IRS creating an extremely
high level flowchart that does not reflect the hundreds of
decision points, exceptions, and complications contained in the
tax code.
IPAA, along with the Domestic Petroleum Council (DPC), has
submitted a proposal providing changes to the existing oil
rules. Unlike the MMS proposal, our proposal complies with the
law and terms of the contract. With each round of comments
(four in total), independents continued to refine their
proposal. Exhibit 2 reflects our current proposal for changing
MMS' rulemaking, which is our fourth round of comments dated
April 6, 1998. These proposed changes use the best evidence
from the lease market for crude oil (consistent with the lease
contract). This proposal provides a consistent, uniform, and
simple approach to valuing non-arm's-length sales or exchanges
of crude oil. Simply put, it preserves gross proceeds for
arm's-length transactions, allows producers who have an
affiliate to look to their arm's-length purchases/sales in the
field or area, and provides for a netback methodology from
index or an affiliate's resale minus all costs, including
marketing costs. If significant quantities of arm's-length
purchases or sales exist, then there is no reason for these
transactions to be ignored for valuation purposes. Poe
Leggette's testimony will provide a more detailed description
of our rulemaking suggestions.
As we move to a comprehensive royalty in-kind program, IPAA
recommends to the Committee that MMS adopt our suggested
changes to the rulemaking (subject to further refinement). We
would be glad to sit down with MMS and other industry
representatives and work out any of the proposal's details to
satisfy its concerns about receiving fair market value. We
believe there are better ways to value oil production than the
``Dungeons and Dragons'' approach.
4. Did MMS' most current proposed rulemaking satisfy the
independents?
In the same letter dated April 30, 1998, MMS suggests that
it adopted a recommendation made by IPAA. Director Quarterman
states ``You should be aware that this tracing provision for
multiple exchange agreements was inserted into the current
proposed rule upon the oral and written recommendation of the
IPAA in public comment on the record. We have not been informed
why they have changed their opinion in their most recent
comments.''
We have already explained to MMS and in public comment
(April 6, 1998), that MMS initially forced a tracing discussion
by arbitrarily requiring any producer who has more than one
arm's-length exchange to pay royalties based on NYMEX. We
responded by stating that this restriction on exchanges was not
fair and suggested the use of multiple arm's-length exchanges
and marketing costs as one method for arriving at a value at
the lease. However, IPAA also has stated that it only supports
this tracing method as a part of a group of valuation options
to be used by lessees in valuing their royalties. In its latest
proposed regulation, MMS has chosen to ignore all of those
options except one: tracing. There is simply no inconsistency
between supporting tracing as an option given to the lessee and
opposing mandatory tracing, which rejects marketing costs. Our
complete response to Director Quarterman's letter, dated May
15, 1998, has been attached for the record (See Exhibit 3).
We would also point out that the MMS has in the past
consistently and repeatedly referred to tracing as the ``least
desirable'' means of determining royalty value. We agree.
Tracing, in the manner described in MMS' proposed regulation on
oil valuation, is impossible in many cases. Industry has made
every effort to inform MMS of the complexities involved, but to
no avail.
The Administration seems intent upon placing the least
desirable regulation possible into effect and continues to
ignore suggestions on how to more efficiently capture values at
the lease. What MMS is doing is picking only those fragments of
our suggestion that perpetuate a complex and costly royalty
system that illegally raises additional revenues.
Royalty In-kind--The Solution
MMS' proposed valuation system makes even the simplest
royalty concept the subject of endless confusion and possible
litigation. After years of failed royalty policies, all
parties, including industry, government, and states, must come
to the table and put an end to costly regulatory and legal
debates surrounding royalty payments. Just as America needs to
reform its tax system, we need to reinvent our royalty system.
Some have said that royalty in-kind is not supported by
independents. This is not true. As an association that
represents thousands of this country's independent oil and gas
producers, we can report that our members enthusiastically
support the Royalty Enhancement Act, as do the independent
members of other trade associations jolning IPAA in these
comments today. Let's not forget that just over a year ago, the
MMS proposed that all producers, including independents of all
sizes, pay their royalties using an impossible NYMEX scheme.
While MMS has retreated from this position, its current
proposal is still fatally flawed. The continued threat by MMS
to challenge our proceeds on the sale of production at or near
the lease has led independents to support the Royalty
Enhancement Act. However, I would also point out that virtually
all producers, including the largest oil companies, support
royalty in kind legislation.
As I stated earlier, MMS must appreciate the potential
benefits of royalty in-kind because it has already conducted a
pilot royalty in-kind program and it is planning three
additional pilots. In its first pilot, which was performed with
natural gas in the Gulf of Mexico, MMS made some critical
mistakes and the program did not live up to its full potential.
MMS failed to use the expertise of the private sector
marketers. We believe similar mistakes will occur with the
upcoming pilot programs. Private marketers could enhance
revenues through aggregation and the assumption of costs and
risks in the downstream market. In the past, MMS used its own
staff who ignored the downstream marketplace. These same design
flaws are resurfacing into the government's next round of pilot
programs.
There are current successful model programs we can look to.
Alberta has already shown that royalty in-kind provides a win-
win situation for governments, taxpayers and oil and gas
producers. In Alberta, 33 people run a royalty in-kind program,
which sells 146,000 barrels of oil per day. MMS' royalty
program employs hundreds of employees to collect its royalties.
Accounting for all this revenue from a myriad of sources
requires an army of accountants, auditors and clerical staff at
a tremendous cost to the government--in excess of $60 million
annually. Under a royalty in-kind system, MMS will only need to
oversee a handful of private marketers, thus reducing the
administrative burden and the number of Federal employees that
will be necessary to account for oil and gas royalties.
The MMS continues to challenge the validity of applying the
Canadian royalty in-kind model to Federal onshore and offshore
production. We should not quibble over the details of the
programs. Yes, lease terms and producing conditions are
different. However, if our neighbor to the North can make
royalty in-kind work, so can the United States. Be it in Canada
or in the United States, the basic tenets of a workable royalty
in-kind program are the same. Through the use of private sector
expertise, a successful royalty in-kind program can be
developed for Federal production, which will yield
efficiencies.
Royalty In-kind Principles
IPAA and a number of other trade associations testified
before this Subcommittee on July 31, 1997, on royalty in-kind,
outlining six principles of a well-designed, royalty in-kind
program. The Royalty Enhancement Act embraces these principles:
1. Reduce administrative and compliance burdens while providing
the opportunity for the Federal and state governments to
maximize their revenues.
The Act provides for a much smaller and more efficient
government agency. No one can dispute this fact. The need for
auditors and lawyers will be dramatically reduced.
Further, the Act provides the government with a golden
opportunity to increase its revenues. The government will use
outside marketing experts to aggregate its volumes, arrange for
transportation, and negotiate the terms and conditions of the
sale. Unlike MMS, we believe that the Congressional Budget
Office will recognize a revenue uplift associated with the
government's opportunity to bring production to a downstream in
aggregated packages. It should be noted that the government's
total volume of production exceeds that of any single lessee.
The Royalty Enhancement Act does contain some cost centers,
such as marketing and transportation. Any increase in price the
government would experience through its qualified marketer
should exceed marketing costs. The same marketing costs we
believe are deductible from the government's proceeds under the
law today. After all, marketing companies are created to make a
profit. If they were not profitable, they would not be in
business.
Transportation costs must be the responsibility of the
government; otherwise the integrity of the program is
compromised. Once the government receives delivery, the
government and its marketer assume exclusive responsibility for
transportation or other downstream costs.
As I mentioned earlier, testimony provided by Mr. Linden
Smith will provide a more detailed analysis the economic
benefits of a royalty in-kind program. If improvements need to
be made to H.R. 3334 to ensure how costs for transportation,
processing, and treating are to be handled, then we stand ready
to work with the Committee to make these improvements.
2. Require transactions at or near the lease that fulfill the
lease obligations.
We believe the Act meets this principle by providing a
workable mechanism for delivery of royalty production and
outlining costs responsibilities that comply with the lease
terms.
3. Require that when the government takes in-kind, it must take
all royalty production for a time certain.
The Act requires that all production be taken in-kind and
does not give the government the right to defer its take
obligation or leave its production in the ground. By having all
production taken in-kind, the Federal Government will receive
all of its royalty value in the most efficient manner. To have
two systems, royalty in-kind and royalty in-value, would not
provide significant cost savings opportunities. It would
increase uncertainty as the government flip-flops between
programs, and it would take away volumes from the government's
portfolio for aggregation. It would require lessees and the
government to maintain dual accounting systems.
For marginal wells, the Act acknowledges two principles:
(1) if the production is flowing into a pipeline, there are no
additional burdens for the government's marketer to take the
product; and (2) for trucked volumes, it is geared to utilize
the existing transporter instead of having the government's
marketer bring in its own truck to a remote well location. By
approaching marginal wells in this manner, the American people
have an opportunity to maximize their benefits from a
comprehensive royalty in-kind program.
There are a number of ways to handle marginal well
production. Keep in mind, the government may realize more
revenues by aggregating marginal production typically sold at
the well, and moving this production downstream. Other options
include allowing the producer to prepay its production or
provide a royalty barrel credit in more prolific wells. If the
government claims it is not cost effective to take production
in-kind from marginal wells, then it probably isn't efficient
to send in a monthly royalty payment that is subject to audit.
A prepayment program resolves this issue and prevents the
government from spending dollars to collect dimes. We suggest
that the Committee consider developing legislative language
bolstering the prepayment option.
4. Require use of private marketing expertise to streamline
operations.
This Act ensures the American people that experts, not
bureaucrats, will be marketing the royalty oil and gas. Through
the development of competitive contract terms with its selected
marketers, the government will be able to maximize returns to
the public.
5. Provide the states with the opportunity to be involved in
designing and implementing the program.
This Act allows a state to assume responsibility for the
royalty in-kind program. IPAA strongly supports this position.
We will leave the details of this involvement to be further
refined by the states and the Committee. As long as all of the
production is being taken in-kind and there is no more than one
gas marketer and oil marketer per lease, state involvement is
encouraged.
6. Make royalties taken in-kind broadly available for public
purchase.
We believe that the concept of continuing to make royalty
in-kind volumes available for sale on a competitive and broad-
based manner is embodied in the Act. We further support the
Secretary's right to promulgate regulations that establish the
mechanism for competitively selecting the government's
marketer.
Conclusion
Independents take royalty issues very seriously and for a
good reason. We've been down this road before. You may recall
the lawsuit IPAA filed against the Department of Interior in
1993 to prevent the illegal collection of royalties involving
take-or-pay contract settlements. MMS was insistent that its
position was correct and that producers should ``just pay up
their fair share'' of royalties on those settlements. It was
the same tune we're hearing now from some quarters. But the
Court of Appeals in Washington ruled that Interior had
unlawfully departed from its own rules through a novel
interpretation of law.
Five years later, not much has changed. The Federal
Government is trying to claim a larger share of royalties
through regulation. And its consultants and advisors are
attempting to collect these royalties by applying the rules
retroactively vis-a-vis a recent lawsuit.
Yes, the Royalty Fairness Law did reform MMS' accounting
practices. However, it did not reform the government's
valuation procedures. The Royalty Fairness Law is the safety
net for producers and states. It ensures that the government
will perform its audits of these complex valuation rules in a
timely manner. But let's not forget that the Royalty Fairness
Law, passed in the 104th Congress, contemplated royalty in-
kind. Those provisions were struck from the bill due to
procedural obstacles in the Senate. To the best of my
recollection, we thought the Administration supported
advancement of royalty in-kind language as part of Royalty
Fairness. It appeared to us that at that time they thought
statutory language was needed to do any further experimenting
with royalty in-kind. We believe statutory language is needed
today.
Unfortunately, a year and a half later, we are once again
discussing the Federal royalty program with Congress. The
government has again changed the rules of the game. And, like
the Federal tax system, changes to this system's rules increase
confusion, frustration levels and administrative costs.
We need to end the royalty debate once and for all, and
give the American people the opportunity to maximize the value
of production from Federal lands in the most cost-effective
manner consistent with the terms of the lease. A well-designed
royalty in-kind program has significant potential to increase
economic efficiency, increase Federal and state revenues,
reduce controversy, and constitute a fairer approach for
Federal and state governments, oil and gas lessees, and the
nation's taxpayers. Independents urge the Congress to ensure
MMS promulgates a reasonable oil royalty rule which is
consistent with the law as we proceed with passage of the
Royalty Enhancement Act. We ask the MMS, States and Committee
to work with us in developing fair and reasonable oil valuation
rules and a successful royalty in-kind program.
------
Statement of Fred D. Hagemeyer, Coordinating Manager--Royalty Affairs,
Marathon Oil Company
I. Introduction
Good afternoon, Madame Chairman and members of the
Subcommittee. I am Fred D. Hagemeyer, Coordinating Manager of
Royalty Affairs for Marathon Oil Company. I am pleased to
appear here today on behalf of the American Petroleum
Institute, whose membership includes companies actively
involved in oil and gas operations on Federal onshore and
offshore lands. The American Petroleum Institute (API)
represents more than 400 companies involved in all aspects of
the oil and natural gas industry, including exploration,
production, gathering, transportation, refining and marketing.
II. Background
There is widespread industry support for royalty-in-kind
(RIK). Last summer, more than a dozen oil and gas trade
associations formed a task force to develop a workable RIK
program. In addition to API, the multi-association task force
included the Independent Petroleum Association of America
(IPAA), the Rocky Mountain Oil and Gas Association (RMOGA), the
Domestic Petroleum Council (DPC), the Independent Petroleum
Association of Mountain States (IPAMS), the Mid-Continent Oil
and Gas Association (MCOGA), as well as numerous state and
regional associations.
The group's mission was ``To design a Federal royalty-in-
kind (``RIK'') program that will eliminate valuation
uncertainty and that will be attractive to Federal, state and
private sector stakeholders while recognizing the differences
between oil and gas production.'' The group was able to achieve
a broad industry consensus in favor of a program that both
streamlines and simplifies the current system and provides an
opportunity to the Federal and state governments to maximize
revenues.
I am here today representing API in support of H.R. 3334,
the Royalty Enhancement Act of 1998. As Representative
Thornberry pointed out when he introduced the Royalty
Enhancement Act, it provides a starting point to begin a debate
on the royalty-in-kind issue. I want to assure you of API's
willingness to work with the Subcommittee to resolve issues
that may arise during the legislative process. We understand
that any change in the current system must meet the needs of
government, as well as those of the oil and gas industry, and
we will cooperate to achieve that goal.
III. Overview of Royalty-In-Kind
API's written submission to this Committee in March of this
year endorsed the concept of royalty-in-kind as a progressive
measure that would simplify the royalty payment system for the
Federal and state governments and the oil and gas industry. It
lays out the reasons why an RIK program would be a substantial
improvement over either the existing oil and gas valuation
system or the proposed valuation system. Six principles were
identified as important to a successful RIK program:
First, it should reduce administrative, compliance and conflict
resolution burdens, while providing the opportunity for Federal
and state governments to increase revenues.
Second, an RIK program should require that lease obligations be
fulfilled at or near the lease.
Third, the government must take all royalty production for a
time certain.
Fourth, the government's oil or gas should be marketed through
a competitive, privatized system.
Fifth, state governments should have the opportunity to
participate in the design and implementation of the RIK
program.
And sixth, the royalty production should be made available on a
competitive basis to a broad-based public market.
We believe that, in large part, these six principles are embodied
in H.R. 3334.
Support for an RIK program comes from both states and industry.
Representatives of the states of Wyoming and Texas testified before
this Subcommittee in July, 1997, that a well designed RIK program would
substantially reduce administrative costs and royalty disputes while
providing the royalty owner with an opportunity to obtain an enhanced
return in markets downstream of the lease market. Understandably, the
states are concerned about the enormous cost of collecting and
verifying royalties paid in value as these costs directly affect the
net revenues they receive from Federal leases. The attractiveness of
RIK lies in the fact that it would reduce administrative costs. Another
important advantage of RIK from a revenue perspective is that
production received in kind may be sold anywhere, in the lease market
or in remote downstream markets. In contrast, when the government takes
royalty in value, it is contractually limited to the value of
production at the lease. We understand that some states have design
concerns about H.R. 3334. We stand ready to work with them on these
concerns, whether they need rewording for correct interpretation or
some amendment is necessary. Creating a workable program is our goal.
Industry's support for RIK results from the need for certainty in
satisfying the royalty obligation. Federal leases require that royalty
in value be reported and paid by the end of the month following
production. Even the existing valuation regulations setting forth how
royalty payments in value must be made are extremely complex and
subject to constant reinterpretation, requiring the expenditure of
considerable resources by both industry and government to handle this
onerous process. All royalty payments made in value are then subject to
audit by the government, usually many years after the payment is made.
Claims for additional royalty take years to resolve through costly
administrative appeals and litigation. As a result, valu-
ation disputes continue for years, and Federal lessees are simply
unable to have certainty regarding the value of production at the time
royalty payment is due.
The central advantage of RIK is certainty. Production taken in kind
and sold at an agreed upon price eliminates the necessity for the
government to try to determine, years after the fact, the ``reasonable
value of production at the lease.'' API believes that a comprehensive
RIK system would result in significantly fewer disputes than an in-
value system. RIK would also give Federal and state governments the
flexibility to participate in downstream markets.
Today, my testimony will focus on how H.R. 3334 could reduce
compliance and conflict resolution burdens and administrative costs for
both the government and industry, while creating an opportunity for the
government to increase revenues from its oil and gas holdings.
IV. How and Why RIK Would Work
Vice President Gore has called for reinventing government. The
proposal for a comprehensive RIK program shows how a government
function can be reinvented to the benefit of all parties. An RIK
program would substantially simplify royalty collection for oil and gas
compared to the existing system or to the MMS's most recent proposal.
Under an RIK program, producers would discharge their royalty
obligations by tendering at the ``delivery point'' physical units of
production, i.e., barrels of oil or cubic feet of gas. The government
would take delivery of its royalty share, which would be marketed on
its behalf by ``Qualified Marketing Agents'' (QMAs) who would be
selected in a competitive bid process to serve as the government's
royalty agents. These private marketing firms would combine royalty
production volumes into packages that are attractive to purchasers.
They could also arrange for transportation and other services so that
royalty production could be moved downstream in a cost efficient
manner. In this way, marketers could seek opportunities for the sale of
royalty production which could enhance the net revenue realized by the
government.
In addition, an RIK system would result in significant
administrative efficiency gains for government and industry, stemming
from reductions in resources devoted to royalty valuation, auditing and
valuation dispute resolution. Rather than relying on the complex
valuation regulations to determine value at the lease, an RIK program
would empower the government to determine value by direct entry,
through the QMA, into the marketplace whether that be at the lease or
in downstream markets. For example, aggregating the government's oil
and gas royalty volumes from the Gulf of Mexico would give the
government as large a volume as any other producer in the Gulf.
Moreover, the competition for that sizable market share of supply is
likely to be vigorous, with many buyers and sellers. Further, the
government would be able to leverage the expertise of the QMA to link
up with buyers in various markets.
V. Gathering/Transportation
Three objectives regarding gathering and transportation should be
addressed in a royalty-in-kind program. First, the lessee should
continue to be responsible for gathering costs for royalty purposes,
and the government should continue to be responsible for the costs of
transportation of royalty oil and gas.
Second, the gathering and transportation sections of an RIK program
should comply with the provisions of the Outer Continental Shelf Lands
Act. Section 5 of this Act obligates the Secretary of the Interior to
require open and non-discriminatory access to pipelines. This section
also prohibits unlawful discrimination in transportation arrangements
for oil. These requirements should apply to RIK production by providing
that the government's royalty portion be moved on the same terms and
conditions as lessee and third-party production. It would be illogical,
and inconsistent with the OCSLA, for government oil or gas to be
transported at a different rate than the rates paid by other producers
to transport production in the same pipeline on the same day. In fact,
the OCS lease form itself provides that ``the lessee shall be entitled
to reimbursement for the reasonable cost of transporting the royalty
substance.'' The best measure of that cost is the rate other
nonaffiliated third parties pay to move production through the same
pipeline on the same day.
The third objective of the gathering and transportation provisions
is to clarify the definitions and interpretations of these terms. The
bill should clearly delineate the movements which constitute
``gathering'' and the movements which constitute ``transportation.''
The bill should also clearly specify the basis for determining the
transportation rates the government would incur to transport its
royalty production.
In order to understand how these objectives are incorporated into
the gathering and transportation sections of H.R. 3334, one must first
understand the role of the delivery point. As defined in the bill, the
delivery point is the measurement point as approved by the MMS
(offshore) or BLM (onshore). Separated production is measured at this
point, and it is a location where custody transfer can easily take
place. The measurement point can be on the lease, adjacent to the
lease, or at some distance from the lease. The MMS may move it to a
point closer to or further from the lease during the life of the lease.
The definition of delivery point in the bill is not intended to be a
dividing line between gathering and transportation movements. The
distinction between gathering and transportation should not be based on
the location of the measurement or delivery point.
``Gathering'' is defined in the bill as ``the movement of lease
production to a central accumulation point on the lease, unit, or
communitized area.'' This definition parallels language in the existing
leases providing for delivery of production on or near the lease or
reimbursement of costs for transportation downstream of the lease.
Gathering has traditionally been on or near the lease and the bill is
not intended to change that lease concept. The language does, however,
need to be clarified to address those situations where the delivery
point is not on or near the lease to clarify that not all movements of
production prior to the delivery point are gathering.
As defined in the bill, ``transportation'' of royalty oil and
royalty gas includes all movement of production downstream of the
delivery point as well as the movement of bulk production prior to the
delivery point in limited circumstances. This language should be
clarified to make it consistent with the lease terms. Generally, the
lease provides for royalty-in-kind to be delivered at a point on or
immediately adjacent to the lease. Offshore leases may provide for
delivery by the lessee to a point onshore with reimbursement by the
government for such transportation.
Looking at the bill's provisions respecting transportation
allowances prior to the delivery point, there are two areas that need
clarification: (1) where transportation costs are currently allowed,
and (2) where subsea transportation is currently being disputed. We
feel that the movement of production in both situations is
transportation, and the transportation language in the bill should be
amended to parallel the lease where transportation is the movement to a
point not on or adjacent to the lease.
The movement of bulk production from subsea production facilities
in deepwater developments does not differ from the situations in which
transportation allowances are currently allowed prior to delivery
point. The use of subsea facilities is a recent technological
advancement that has enabled development of fields remote from existing
infrastructure, and which fields, in many instances, would not have
been economic utilizing traditional surface platform developments.
Movement of production from subsea facilities on a lease may be for
great distances, up to sixty miles or more.
Another issue involving subsea production is where pipeline quality
gas is produced at the well and does not require further treatment
prior to compression for movement to shore. Such production is, by
necessity, transported via pipeline significant distances away from the
lease to other locations onshore. Categorizing this type of movement as
transportation is consistent with lease language and other approved
transportation allowances.
H.R. 3334 clearly recognizes three basic categories of
transportation applicable to RIK volumes: (1) shipment through
pipelines not affiliated with the lessee, (2) shipment through non-
regulated pipelines owned by or affiliated with the lessee, and (3)
shipment through regulated pipelines owned by or affiliated with the
lessee.
First, with regard to transportation on pipelines not owned by or
affiliated with the lessee, the legislation provides that the lessee
will be reimbursed for transportation upstream of the delivery point.
The QMA will arrange downstream transportation directly with the
carrier. Guidelines are provided for costs upstream of the delivery
point to be the actual costs incurred by the lessee. We believe that
the government will control sufficient volumes of production to
negotiate favorable downstream transportation arrangements. Further, if
the transporting pipeline is subject to rate regulation under existing
law, the government will never pay more than the maximum approved rate
for transportation.
Second, for transportation on affiliated pipelines, the proposed
legislation distinguishes between regulated and non-regulated pipelines
owned by a lessee or an affiliate. If an affiliated pipeline is
regulated, then, as with non-affiliated regulated pipelines, the
government will reimburse the tariff rate upstream of the delivery
point or negotiate a rate downstream of the delivery point with the
carrier, but the government will never pay more than the maximum
regulated rate for transportation.
Third, with reference to transportation on unregulated pipelines of
affiliates of lessees, the bill contains extensive safeguards to ensure
that the government is never charged more than a commercially
reasonable rate.
To further ensure against the possibility of excessive charges on
affiliated pipelines, H.R. 3334 provides that the negotiated rate
charged to the MMS or QMA on behalf of the United States may not exceed
the highest rate charged a non-affiliated shipper by the pipeline. That
rate cap reflects a market-determined price and is an appropriate
measure to use in setting the upper limit of commercial reasonableness.
If the pipeline moves only the production of its producer affiliate,
then the negotiated rate cannot exceed the fair commercial value of the
transportation services provided. If the affiliated pipeline and the
QMA cannot agree on a rate, the bill provides for arbitration to
determine the appropriate rate payable for transportation services
rendered by the affiliated pipeline.
Furthermore, movement of water was not intended to be a
responsibility of the government, but only the transportation of
royalty oil and royalty gas. We would support an amendment, if needed,
to clarify that the costs associated with the transportation of water
are the responsibility of the lessee.
VI. Processing of Royalty Gas
Under existing MMS regulations, a gas processing plant is a
facility that utilizes physical processes to remove elements or
compounds (hydrocarbon and non-hydrocarbon) from gas, including
absorption, adsorption, or refrigeration. Gas processing plants are
located downstream of the point of production and often process
production originating from more than one field. Under H.R. 3334, the
processing of royalty gas can occur downstream of the delivery point
for royalty gas.
Currently, a lessee can sell its gas outright or enter into a gas
processing agreement to have its gas processed and thereby recover the
substances entrained in the produced gas stream; these include
hydrocarbon products such as ethane, propane, butane, and natural
gasoline. The removal of such products may or may not be required in
order to make the gas comply with the specifications of the
transporting gas pipeline.
Generally, gas processing agreements are entered into only if each
party, the producer and the plant owner, expects to realize a long-term
economic benefit. For the plant owner, processing the producer's gas
stream must yield sufficient revenues to justify the very significant
cost of constructing and operating the plant. These same principles
will apply when the government takes its royalty gas in kind and seeks
to have it processed by a plant owner.
H.R. 3334 leaves processing terms for resolution by market forces
through negotiations between the government, acting through the QMA,
and the plant owner.
Processing is generally distinct from ``treatment,'' which refers
to operations typically performed at or near the lease, in order to put
production in marketable condition. Costs, including treatment, to put
production in marketable condition are not deductible under current
royalty valuation regulations. Since in the majority of cases,
treatment is done by the lessee at or near the point of production and
upstream of the delivery point, we do not believe the bill would affect
any material change in cost responsibility.
VII. Imbalances
H.R. 3334 requires producers to deliver, and the government's QMA
to take, 100 percent of the Federal royalty volumes at the delivery
point. H.R. 3334 also recognizes that normal operational imbalances
occur on a well from month to month and provides a mechanism to assure
that all parties, including the United States, will receive their
proper shares of the production.
Oil and gas transporters and purchasers operate on a system which
requires the seller, shipper, and purchaser to nominate quantities
prior to actual shipment. Since it is impossible to know the precise
quantity that will be produced the next month, there is always a
difference, though usually a small one, between the nominations and
actual production.
Although H.R. 3334 requires the government to take its full royalty
share, it provides a mechanism to permit adjusting future quantities
taken in kind to bring these small monthly differences into balance
over time. The provision also provides a mechanism for final settlement
of any imbalance that is remaining after the production ceases on an
individual Federal lease. These procedures are consistent with industry
practice and ensures that all parties are treated fairly.
VIII. Qualified Marketing Agents
This Subcommittee has heard from some mid-stream marketers who are
potential QMAs under an RIK program. These marketers are very
supportive of RIK legislation and are interested in the opportunity to
act on behalf of the Federal Government in seeking to maximize royalty
revenues from Federal oil and gas production. The experience and
expertise of these marketing companies and individuals are the key to
the benefit that the government can derive from RIK.
The use of experienced QMAs, instead of the government marketing
its own production, will benefit the government in at least four
respects:
<bullet> First, QMAs offer the ability to maximize flexibility
by marketing royalty volumes either at the lease markets or
away from the lease in downstream markets.
<bullet> Second, they offer the opportunity for cost savings in
arranging transportation by aggregating the government's
royalty volumes from individual leases into larger packages.
Also, there is the opportunity of aggregating royalty volumes
with other volumes handled by the marketer.
<bullet> Third, QMAs' expertise provides the ability to respond
quickly to rapidly changing lease and downstream markets.
<bullet> And fourth, the government can use an established and
expert marketing organization, rather than creating and
training an MMS government marketing organization.
Under H.R. 3334, the government is not restricted in its choices of
QMAs. By soliciting competitive bids, government agencies, both state
and Federal, can acquire the best available marketing expertise. The
QMA would then handle the disposition and sale of the government
royalty share taken in kind. Furthermore, the MMS would monitor and
assess the performance of QMAs. If performance were deemed inadequate,
the government could change marketing agents.
The MMS' concern about QMAs not performing in an open, competitive
and non-discriminatory manner in transactions with affiliates is
unfounded. Indeed, the exclusion of producing companies or their
affiliates from consideration as QMAs, or the marketing of royalty oil
and gas by QMAs to affiliates, would place considerable marketing
expertise off-limits to the government. Moreover, the MMS can structure
the regulations and its contractual arrangements with its QMAs in such
a way that they have an incentive to maximize the revenues realized on
their sales of royalty production.
IX. Revenue Implications
Given the huge volume and diversity of transactions, scoring--or
estimating the effect on government revenues--for Congressional Budget
Office (CBO) purposes may be difficult, but it can be accomplished. In
particular, the CBO should start with the terms used to define the
lessee's royalty obligation in current oil and gas leasing statutes.
For example, the OCS Lands Act requires that royalty be paid on a
percentage in ``amount or value'' of the ``production saved, removed or
sold from the lease.''
This statutory language is important because the MMS and industry
agree that the value of production does not include the cost of
transportation. What the MMS and industry disagree on is whether the
value of production should include all downstream costs. This MMS view
on downstream costs and its increasing tendency to apply netback
methodologies to inflated downstream market values shows up in its
pending crude oil valuation proposal and its final gas transportation
allowance rule. This skews its revenue expectations under its
existing--and proposed--valuation regulations upward and therefore by
comparison understates the revenues that would be generated under the
pending RIK legislation. The outcome of this debate is of critical
importance to the pending RIK legislation, because it affects the
baseline against which any projections of future revenue are measured.
MMS points to the 1995 gas RIK pilot program as an example of RIK
resulting in a possible revenue loss, and it maintains more RIK pilots
are necessary before moving forward with RIK. In actuality, the 1995
gas pilot was enormously successful. It proved that MMS, Federal
lessees, operators and purchasers could easily accommodate RIK from an
operational standpoint. Lines of communication between operators and
purchasers were established, transportation services were arranged, and
reports by lessees and purchasers were generated, all with relative
ease. Significantly, a mere handful of MMS employees were able to
manage the pilot, far fewer than would have been required to collect
and verify royalty paid in value on the same production.
MMS analyzed the revenue impact of the 1995 gas pilot by comparing
values reported by RIK gas purchasers against values reported by
lessees for the working interest share of production. As a general
matter, there were some problems--previously identified by API in a
critique of the MMS natural gas RIK pilot program--with the manner in
which the revenue impact analysis was performed. In fact, had the
revenue analysis been appropriately conducted, it is possible that MMS
would have concluded the pilot actually made money. In addition, MMS
failed to effectively measure administrative cost savings.
Certainly, any more pilots that do not take advantage of the
lessons learned in the 1995 gas pilot are unwarranted and would be a
waste of time. The problem is that MMS cannot obtain the private
marketing expertise it needs in order to contract with a marketing
agent to sell RIK production downstream without legislation. H.R. 3334
provides the legislative framework that will enable MMS to take
advantage of downstream markets.
X. Conclusion
In summary, my purpose here today is to help re-engineer an
important government function for the benefit of all concerned: the
state and Federal Governments, the public, and the oil and gas
industry. A properly designed RIK program can be fair to all
stakeholders. It can be more efficient by streamlining administration
and eliminating unnecessary valuation disputes. Finally it can offer
Federal and state government the opportunity to increase royalty
revenues in markets downstream of the lease.
In closing, I thank you for the opportunity to be here today
representing the API and to participate in this important undertaking.
We believe RIK is not only simpler, it is better, and a comprehensive
royalty-in-kind program deserves careful consideration. API is
interested in working with this Subcommittee, the MMS, the States, and
other stakeholders toward achieving a workable solution that meets the
needs of all parties. As part of this effort, API would welcome an
opportunity to discuss differences between MMS and industry concerning
provisions in this bill with the common goal of successfully
reinventing an important government process.
______
Statement of Bob Neufeld, Vice President, Environment and Governmental
Relations, Wyoming Refining Company representing Wyoming Refining
Company, Calcasieu Refining Company, Gary-Williams Energy Corporation,
Giant Refining Company and Placid Refining Company
Chairman Cubin and members of the Subcommittee:
My name is Bob Neufeld. I am the Vice President of
Environment and Governmental Relations for Wyoming Refining
Company. Wyoming Refining Company is a member of a coalition of
five small and independent refiners called the Small Refiner
Consortium (Consortium) who are purchasing or have purchased
Federal royalty oil from the Minerals Management Service. The
United States have been selling some of their Federal royalty
oil since the Federal Mineral Leasing Act was amended in 1946
to ensure that small, independent refiners would have secure
access to crude oil markets. That program which has operated
successfully to the benefit of small refiners and the Nation
for fifty years is now becoming an instrument for the
elimination of the small refining industry in this country. As
I testified at the Subcommittee's September 18, 1997 oversight
hearings on the Federal oil and gas royalty program, current
MMS dependence on a methodology that mimics rather than
participates in the markets for crude oil is misguided. This
dependence has led to retroactive crude oil price adjustments
for small refiners as many as 8 years after invoices issued for
the sale of the oil were paid in full and on time.
My company is now in litigation with MMS over amounts,
based on producer audits conducted without our knowledge, that
may exceed our stockholders' equity. These amounts cover oil
sold by MMS after MMS had concluded, without informing us, that
prices in our invoices might be wrong because of a producer's
reporting error. Wyoming Refining was lured, therefore, into
increasing its financial exposure by purchasing oil whose price
was suspect, but only to MMS. Furthermore, MMS effectively
ensured that our right to cancel further deliveries of over-
priced oil would lapse unexercised by waiting for years after
delivery to raise the issue. While the other four members of
our coalition have not as of this writing received MMS demand
letters for retroactive Federal royalty oil price adjustments,
MMS has informed them that demand letters to refiners other
than Wyoming Refining Company will be issued by December of
this year. All members of the Consortium fear that the impact
of these letters on them could be as bad or worse than the
disaster facing Wyoming Refining Company.
Madam Chairman and members of the Subcommittee, I am
testifying today on behalf of all members of the Consortium and
in favor of H.R. 3334 to ensure that this impending disaster is
never, ever repeated. The current Federal dependence on market
mimicry, second guessing and non-market, wastefully expensive
adjudication to set royalty values must end. Actual market
participation is the only reliable, irrefutable and final
measure of Federal oil values.
Before commenting on the more important eligible small
refiner provisions in H.R. 3334, I want to state on behalf of
the entire Consortium that we categorically disagree with MMS'
mis-characterzation of Sec. 12 of the bill as ``minimizing the
value of 40 percent of the government's royalty oil'' and as
requiring ``the government to pro-
vide 40 percent of its oil to small refiners at the lowest
offered prices.'' To the contrary, the bill requires that the
eligible small refiner portion of oil volumes be offered to
refiners for exactly the same price as that oil would otherwise
be sold to successful purchasers or bidders. It is difficult to
see how this lowers the price of oil and, in fact, it is just
as plausible to assume that the price of oil will be increased
by purchasers or bidders competing to stay above the bottom 40
percent of successful offers.
The Consortium is particularly disturbed by MMS' equating
the ``lowest successful offers'' language in H.R. 3334 with
``the lowest offered prices'' description in the agency's
report. The two concepts are fundamentally different, and MMS
should know better. MMS' comments are subtly but crucially off
target. When serious factual discussion is required,
deliberations are not furthered by obfuscation that clouds the
debate. Misguided analysis such as this raises questions of
whether MMS has similarly mis-characterized any more of H.R.
3334 in its report to the Subcommittee.
The Consortium participated in drafting the eligible small
refiner provisions of H.R. 3334 contained in Sec. 12 and
related definitions of the bill. We believe we have been
successful in keeping the original intent of existing eligible
small refiner royalty-in-kind authority which Sec. 12 would
replace while merging together the existing onshore and
offshore programs and simplifying overall program
administration. The following narrative discusses the key
eligible small refiner provisions contained in H.R. 3334.
SECTION 2. DEFINITIONS.
(6) ELIGIBLE SMALL REFINER.--The term ``eligible small
refiner'' means a refiner that----
(A) has applied to the Secretary for and has received
certification as an eligible small refiner;
(B) has a total crude oil and condensate refining capacity
(including the refining capacity of any person who control, is
controlled by, or is under common control with such refiner)
not exceeding 120,000 barrels per day;
(C) is a corporation, company, partnership, trust or estate
organized under the laws of the United States or of any State,
territory, or municipality thereof, or is a person who is a
United States citizen; and
(D) has continuously operated a refinery in the United
States for no less than 6 months immediately preceding the date
of application for certification as an eligible small refiner.
This proposed definition of ``eligible small refiner''
ensures that the program continues to benefit the domestic
refineries of American small refiners who would not otherwise
have equitable access to Federal oil production.
It is necessary to change the current size criterion of
eligible small refiner in the above manner and to consolidate
the different definitions into one to reflect industry changes
and the current refining environment. The existing offshore
definition is tied to the Small Business Administration
definition which caps refining capacity at 75,000 barrels per
day and the employee count at 1,500. The existing onshore
definition is tied to the Emergency Petroleum Allocation Act of
1973 which caps refining capacity at 175,000 barrels per day
and addresses historical sales to independent wholesalers and
jobbers.
With the recent industry consolidations and strategic
alliances, the traditional small refiner may not survive
without growing in both the refining and the market sectors. In
the refining sector, only inherent efficiencies and economies
of scale will allow a refiner to remain competitive. Economies
of scale are generally achieved by geometric growth versus
incremental growth. However, the need exists to have an overall
cap on refining capacity to stay within the intent of the small
refinery royalty-in-kind concept. At 175,000 barrels per day a
refiner is truly no longer small in size. A restriction of
75,000 barrels per day severely restricts growth through
acquisition or merger. Discussions were held and 120,000
barrels per day distillation capacity was determined to be an
acceptable boundary between those refiners who truly are small
and those who are not.
Growth in the market sector primarily occurs through
wholesale, retail, military and commercial sales as well as
through supplying intermediate feed stocks and specialty
products to other refiners. The only guarantee a small refiner
has for refinery out turn is through controlled retail outlets
and preference sales to the military. By growth on the retail
level, the refiner is creating jobs, adding a labor intensive
business and guarantying an outlet for the product. This
expansion in a small refiner's corporate size has no
relationship to its refining capacity or the need to preserve a
diverse base of domestic refiners. Therefore, the employee
count cap was eliminated.
(7) ELIGIBLE SMALL REFINER PORTION. The term ``eligible small
refiner portion'' means the portion of all royalty oil volumes
required to be offered for sale to eligible small refiners. The
eligible small refiner portion shall be 40 percent of all
royalty oil volumes, unless the Secretary determines that a
greater share is in the public interest.
The Minerals Management Service has stated that in 1996,
the last date for which information is available, forty percent
(40%) of all royalty oil revenues were received from
participating refiners in the royalty-in-kind programs. The
definition of the eligible small refiner portion reflects what
has occurred in the program. Smaller percentages for earlier
years reflect a period when offshore Federal royalty oil was
not available to eligible small refiners thereby inaccurately
skewing the royalty-in-kind revenues, derived solely from
onshore sales, toward a lower percentage of total Federal oil
revenues.
SECTION 12. ELIGIBLE AND SMALL REFINERS
(a) SALE OF ROYALTY OIL TO ELIGIBLE SMALL REFINERS
(2) The sale of royalty oil from the eligible small refiner
portion to an eligible small refiner is intended for
processing, or trading for equivalent barrels for processing,
in the eligible small refiner's refineries located in the
United States and not for resale in-kind or value.
The participating refiner must process, directly or
indirectly, the Federal royalty oil received under this Section
12.
(4) The eligible small refiner portion shall be offered to
eligible small refiners from royalty oil volumes to be sold by
each qualified marketing agent. The Secretary shall maintain a
current list of all eligible small refiners. Upon the selection
of a qualified marketing agent by the Secretary, the Secretary
shall promptly notify all eligible small refiners of the
selection of the qualified marketing agent. The notification
shall contain the name and address of the qualified marketing
agent as well as a brief description of the Federal leases and
lease products to be marketed by that qualified marketing
agent. Any eligible small refiner who is interested in
receiving royalty oil from the leases of the qualified
marketing agent, shall submit a notice of interest to the
qualified marketing agent. The notice of interest shall
generally state the volumes, location and quality of royalty
oil desired by the eligible small refiner. When marketing
royalty oil, each qualified marketing agent shall contact the
eligible small refiner(s) who has (have) submitted a notice of
interest and shall offer to sell the eligible small refiner
portion to the eligible small refiner(s) who submitted a
notice. If there are successful offers for all royalty oil
volumes to be sold, the eligible small refiner portion price
shall be the weighted average price of the 40 percent of
royalty oil volumes to be sold for which the lowest successful
offers have been received. If a part of the royalty oil volumes
to be sold does not receive a successful offer, for weighted
average pricing purposes, that part shall be valued using the
price of the lowest successful offer.
This concept is very similar to the manner under which the
Naval Petroleum Reserve Elk Hills Field oil was sold with very
successful results and an apparent minimum amount of
administration. The concept guarantees that Federal royalty oil
will be sold at a price no less than it would have otherwise
have been sold and overall has the potential to generate
additional revenue.
I must note for the Subcommittee's information that H.R.
3334 and the companion Senate bill, S. 1930, contain differing
language in this section. We have been working with the
producing industry to reconcile this difference between these
two bills. The language appearing in this testimony represents
agreement between the Consortium and the producing industry
representatives except for the last two sentences. Both sides
are endeavoring to find a mutually acceptable position on this
one remaining issue, and we believe any differences will be
resolved shortly. For the Subcommittee's information, in lieu
of the last two sentences discussed above, S. 1930 contains the
following language, ``The eligible small refiners shall
purchase such royalty oil at the weighted average price for the
remaining volumes of like quality at the same location sold by
the qualified marketing agent.''
(c) FEES, CREDITWORTHINESS, AND SURETY REQUIREMENTS.--(1)
The purchase of royalty oil from the eligible small refiner
portion pursuant to this section shall not be subject to any
fees or charges not required of all purchasers of royalty oil.
(2) The Secretary shall establish conditions for each
eligible small refiner's creditworthiness at the time of
determining and reviewing eligibility.
(3) Creditworthiness requirements for eligible small
refiners shall not exceed standard industry requirements
governing non-Federal crude oil pur-
chasers, and the Secretary may not require surety in excess of
the estimated value of 60 days anticipated deliveries of
royalty oil from the eligible small refiner portion to
individual eligible small refiners.
With a global royalty-in-kind program as introduced in this
bill, eligible small refiners should be held to the same fees
and credit requirements as any other arms-length purchaser from
the qualified marketing agent.
(d) ELIGIBLE SMALL REFINER ADVISORY PANEL--The Secretary
shall convene an eligible small refiner advisory panel to
develop policies and procedures to implement the provisions of
this Act. The eligible small refiner advisory panel shall be
comprised of representatives from 3 small refiners who have
previously participated in the small refiner program
established pursuant to section 36 of the Mineral Leasing Act
(30 U.S.C. 192) or section 1353 of the Outer Continental Shelf
Lands Act (43 U.S.C. 1353) and 3 qualified marketing agents.
Pursuant to the recommendations of the small refiner's advisory
group, the Secretary shall develop and implement procedures to
ensure a fair and equitable opportunity for interested eligible
small refiners to purchase royalty oil from the eligible small
refiner portion.
We are encouraging the MMS to team with the eligible small
refiners and qualified marketing agents to develop workable
policies and procedures to minimize the administration and
implement the intent of the Act.
(g) REPEAL OF EXISTING ROYALTY-IN-KIND AUTHORITY.--Section
36 of the Mineral Leasing Act (30 U.S.C. 192) and section 1353
of the Outer Continental Shelf Lands Act (43 U.S.C. 1353) are
repealed.
This bill would repeal all existing authority for eligible
small refiner royalty-in-kind programs.
CONCLUSION
In closing, Madam Chairman and members of the Subcommittee,
the Consortium states that its members support H.R. 3334 as a
constructive effort to change the Federal oil and gas royalty
program from a system that constantly looks backward to one
that sees the future from a market based perspective. In so
doing, we believe H.R. 3334 preserves and improves upon the
best aspects of the current eligible refiner royalty-in-kind
program, a program that after fifty years remains relevant
today in its goal of maintaining a diversified and healthy
refining industry in America. By the same token, H.R. 3334
ensures that the errors of today's small refiner program which
are posing unintended and unbelievable burdens on these
important businesses through no fault of their own will,
thankfully, be discontinued. The Consortium urges your support
and favorable consideration of H.R. 3334. Thank you for the
opportunity to appear on this panel today.
------
Statement of L. Poe Leggette, Jackson & Kelly on behalf of Independent
Petroleum Association of America
On December 20, 1995, the Minerals Management Service
(``MMS'') published in the Federal Register an advance notice
of proposed rulemaking on the subject of crude oil valuation.
In that notice, MMS focused primarily on the concern that crude
oil posted prices ``don't always reflect market value and in
fact may often be no more than a beginning point for
negotiation.'' 60 Fed. Reg. 65610 (1995). Nothing in the
notice, however, indicated that the MMS had begun to view
prices on the New York Mercantile Exchange (``NYMEX'') as the
true ``market value'' of crude oil.\1\
According to documents released under the Freedom of
Information Act, on September 5, 1996, MMS was briefed by a Mr.
J. Benjamin Johnson on modifications he advocated to MMS's
rules on valuing crude oil. Mr. Johnson advocated using a NYMEX
price for oil to be delivered in Cushing, Oklahoma, as the
starting point in royalty valuation. Recognizing that Cushing
is hundreds and sometimes thousands of miles from the Federal
leases in question, Mr. Johnson proposed a complicated series
of adjustments to the NYMEX price to try to reflect
differences. These included using ``grade trade differentials''
among various ``major market centers'' for crude oil (such as
Midland, Texas, and St. James and Empire, Louisiana), and
requiring lessees and their affiliates to report all exchange
agreements to permit MMS to create a national average exchange
differential.
This September 1996 briefing has special significance for
two reasons. First, Mr. Johnson had already filed in Lufkin,
Texas, a complaint under seal under the False Claims Act
seeking for himself up to 30 percent of what he alleged were
billions of dollars of underpayments and penalties associated
with crude oil from Federal leases. Second, MMS adopted his
recommendations with little modification and proposed them in
its January 1997 proposed rule.\2\
I do not yet have the evidence to tell the Subcommittee
whether MMS was Mr. Johnson's witting or unwitting accomplice
in his effort to promote his litigation position. Needless to
say, however, it would lend significant credibility to his
extreme litigation position to have MMS dramatically revise its
rules in response to his allegations that Federal lessees have
systematically underpaid royalties on crude oil.
Since January 1997, independent producers have been
fighting to beat back MMS's proposal that initially would have
required virtually all independents to pay royalties based on
NYMEX prices. While their efforts have met with some success,
the rule remains objectionable for reasons detailed in the
several sets of comments filed in that rulemaking by the
Independent Petroleum Association of America (``IPAA'') and the
Domestic Petroleum Council (``DPC''). One significant objection
is the proposal's complexity, visually depicted on what
Representative Tauzin has aptly named the ``Dungeons and
Dragons'' chart, presented at the Subcommittee's March 19
hearing on H.R. 3334. Independents' other key objections are
founded on the proposed rule's departure from legal precedent.
The Congress historically has given the Secretary of the
Interior significant latitude in determining what the ``value
of production'' is for production from a given lease, as long
as his determinations remain within the perimeter fence of
reasonableness. But Congress, the courts, and the Department
itself have been clear on several fundamental principles by
which these determinations are to be made.
<bullet> First, the value of production is to based on the
value of production at the lease, not, as one court put it
well, ``at the pipe line destination.''\3\
<bullet> Second, the value of production is to be determined by
the terms of the lease contract and by any regulations
incorporated into that contract on the date the lease was
issued.\4\
<bullet> Third, because of the Secretary's unilateral power to
draft lease forms and regulations, the Secretary is not
permitted to enforce royalty-related powers or duties
``implied'' in the lease. If the Secretary fails to write a
duty expressly into the lease or regulations, it does not
exist.\5\
These three primary principles have corollaries, the most important
of which for today's purpose are two.
<bullet> The value of oil at the lease is best reflected in
prices paid at the leased.\6\
<bullet> When the first sale of oil occurs away from the lease,
the ``gross proceeds'' clause of the Federal lease form
requires that the value be based on the lessee's ``gross
receipts'' from the sale ``less the costs of marketing and
transportation.''\7\ These deductions are needed to account for
the fact that when production ``is valued at a point downstream
from the wellhead where the value of production is ordinarily
determined, allowances are generally required for the value
added to the gas [or oil] after production.''\8\
The Subcommittee will find in the testimony of Dr. Joseph P. Kalt
that these two corollaries of law fit hand in glove with fundamental
economic reasoning and sound public policy.
Throughout the MMS's 1997-98 rulemaking, producer associations have
urged MMS to return to a system of valuation more closely aligned with
these bedrock legal principles. For example, in an eleven-association
letter dated December 5, 1997, producers urged MMS to pursue policies
and rules consistent with 6 points.
<bullet> Royalty must be based on the value of production at
the lease.
<bullet> For arm's-length contracts, royalty value should be
based on the lessee's gross proceeds.
<bullet> For non-arm's-length contracts, MMS should continue to
rely on comparable sales at the lease, including sales under
so-called ``tendering programs'' and purchases at the lease by
lessees' affiliates. The associations specifically agreed with
the prospective elimination of posted prices from any set of
valuation benchmarks.
<bullet> Any lessee duty to market cannot result in values
greater than the value of production. In other words, MMS must
recognize that it cannot have a free ride on a lessee's
downstream activities which add value to crude oil.
<bullet> Uniform rules are preferable to separate rules
applying to different regions.
<bullet> Royalty in kind remains the best way to end the
complications and uncertainties of royalty valuation.
Even more specifically, IPAA and DPC invested extensive time in
preparing an alternative sets of royalty valuation procedures
(``RVPs'') to simplify the current rules and to fix MMS's perceived
deficiencies in them. RVPs basically use a lessee's own arm's-length
sales, or its affiliate's own arm's-length purchases, of oil in a given
field as the primary means of valuing oil sold not at arm's length.
This proposal has the twin virtues of relying on arm's-length sales at
the lease and of simplicity in auditing, for the lessee would not need
to worry about expense and legal risk of learning what its competitors
were selling oil for.
Under the RVPs, if a lessee has no arm's-length sales or purchases
to rely on, it must use a netback method of valuation. This could
include using its differentials in exchange agreements as deductions
from an arm's-length sales price for oil it sells downstream or using a
index price with deductions for all value added by the movement of oil
from the lease to the index pricing point. (See Attachment 2.)
Obviously, MMS has yet to embrace these principles and procedures.
Its most recent proposal does not rely on lease market sales to value
non-arm's length sales, except in the Rocky Mountain region where
highly restrictive benchmarks are available to integrated companies,
but not to independents. It limits the amount of transportation costs a
lessee can claim as a transportation allowance. It forbids the
deduction of any downstream service which MMS determines is not a cost
of transportation on the ground that those are marketing expenses which
the Federal Government need not share in. It discriminates irrationally
between lessees who sell at arm's-length at the lease and those who
sell to an affiliate, essentially imposing a tax on much of the value
the affiliate adds to the lease value of oil by moving it downstream.
In conclusion, MMS and producers stand at the brink of years of
litigation over the crude oil rule, a particularly unfortunate
development when one considers that 10 years of litigation have brought
increased stability and certainty to the implementation of the 1988
value rules currently in force. MMS has yet to advance a legally
sufficient reason to end its historical reliance on lease market sales
to value crude oil.
Endnotes
1. The notice contained a single hint that MMS might be considering
a scheme relying on prices agreed to for contracts for the future
delivery of crude oil: a one-sentence question on whether ``oil
`futures' prices provide meaningful bases for royalty valuation.'' 60
Fed. Reg. 65611 (1995).
2. 62 Fed. Reg. 3742 (1997).
3. Continental Oil Co. v. United States, 184 F.2d 802, 820 (9th
Cir. 1950). Congress has required the Secretary to reserve a royalty
based on the ``value of production removed or sold from the lease.'' 30
U.S.C. Sec. 226(b)(1)(A). MMS Director Quarterman acknowledged in an
April 7, 1998, article in The Oil Daily that ``the government is
entitled to a royalty on the value of production in marketable
condition at the lease.''
4. Attachment 1 is a compendium of Federal lease forms. See Tab Q.
for example. The lease expressly incorporates regulations ``in
existence upon the effective date of this lease. . . .'' Sec. 1.
5. Continental Oil Co., 184 F.2d at 810; United States v.
Seckinger, 397 U.S. 203, 210 (1970).
6. This view is reflected in the Department's historical practice
of valuing non-arm's-length sales at the lease by comparison with
arm's-length sales at the lease, e.g., Getty Oil Co., 51 IBLA 47
(1980), and by its practice of valuing production when there is no
market at the lease by using the value of oil at the ``nearest
potential market'' and allowing a deduction for transportation only to
that point. Viersen & Cochran, 134 IBLA 155, 165 (1995).
7. Marathon Oil Co. v. United States, 604 F. Supp. 1375, 1384 (D.
Alaska 1985), aff'd 807 F.2d 759 (9th Cir. 1986), cert. denied 480 U.S.
940 (1987).
8. Xeno, Inc., 134 IBLA 172, 180 (1995) (citing Marathon Oil Co.).
To be sure, the Interior Board of Land Appeals has issued a few
decisions holding that lessees have an implied duty to market
production at no cost to the Federal lessor. The error of those
holdings--which no court has ever affirmed--is currently the subject of
a petition for reconsideration pending before IBLA in Taylor Energy
Co., IBLA 94-828R, and is set forth in the attached amicus brief filed
by IPAA. (Attachment 3.)
ATTACHMENTS
ATTACHMENT 1 Independent Petroleum Association of America and Domestic
Petroleum Council's April 7, 1998 Compendium of Federal Lease Forms
ATTACHMENT 2 Independent Petroleum Association of America's Modified
Valuation Proposal
ATTACHMENT 3 Taylor Energy Co., Motion and Brief Amicus Curiae of the
Independent Association of America, IBLA 94-828R, dated April 24, 1998
______
Statement of Ralph DeGennaro, Executive Director, Taxpayers for Common
Sense
Good afternoon. Madam Chair thank you for the opportunity
to testify before this Subcommittee. My name is Ralph DeGennaro
and I am the Executive Director of Taxpayers for Common Sense
(TCS).
TCS is dedicated to cutting wasteful government spending
and subsidies and keeping the budget balanced through research
and citizen education. We are a politically independent
organization that seeks to reach out to taxpayers of all
political beliefs in working toward a government that costs
less, makes more sense and inspires more trust. Taxpayers for
Common Sense receives no government grants or contracts and is
not party to any royalty litigation.
To put my testimony in context, I would like to outline two
principles that guide TCS's work. First, oil, gas, and other
minerals on public lands belong to the taxpayers--they are
taxpayer assets. Second, these taxpayer assets should be
disposed of in a way that maximizes the return to taxpayers of
today and tomorrow as well as minimizes burdens on the
government.
In accordance with these principles, TCS opposes H.R. 3334
because the legislation is likely to lose revenue and place a
new burden on the government. This new burden of marketing and
selling oil and gas would contradict current efforts to reduce
the size of government bureaucracy and get the government out
of inappropriate roles.
I. LIKELY TO LOSE REVENUE
Though supporters of H.R. 3334 claim that mandatory royalty
in kind (RIK) payments increase government royalty revenue, or
at least maintain current revenues, we believe it will be a
money loser.
A. FRAMEWORK RIGGED AGAINST TAXPAYERS
Supporters of RIK legislation point to examples in Texas
and Alberta where governments have been able to make money
under an in kind system. We believe there may be cases where
the government can make money under RIK, but there are many
others where it will lose. In cases where MMS can make money
through RIK, it currently has the statutory authority to do so,
making this bill unnecessary.
H.R. 3334 does not provide the same framework that has
enabled RIK to succeed elsewhere, but instead is rigged to
virtually guarantee that the Federal Government would lose
money. Garry Mauro, Texas Land Commissioner and administrator
of Texas's RIK program, pointed out in his letter to
Representative William Thornberry that the factors that have
enabled RIK to succeed in his state are the very elements that
the proposed Federal program would lack. For example, Texas'
program is flexible and allows the state to decline RIK for
leases which have small volumes or are in remote areas. In
contrast, the proposed Federal program would be inflexible. The
Federal Government would not be able to select the lands on
which RIK would be beneficial, but instead would be forced to
take oil and gas in kind for all leases. Key differences such
as these led Mr. Mauro to conclude that ``Based upon our
experience with the State program, we think this Bill [H.R.
3334] will result in a loss of revenue to the Federal
Government and the states.'' The States of New Mexico,
California, and Alaska have also opposed the reduction to their
oil and gas royalties they believe will result from the above
provisions. The State of Alaska has concluded that ``this
legislation is a bad idea and will cost Alaska money.''
B. MINERALS MANAGEMENT SERVICE ANALYSIS DEMONSTRATES LOSSES
There is no evidence that mandatory in-kind royalty
payments will be helpful to taxpayers or raise government
revenue. According to MMS's 1997 Royalty in Kind Feasibility
Study, ``despite direct inquiries, marketers were not able to
provide convincing arguments or evidence that oil RIK would be
revenue positive.'' Therefore claims of increased revenue are
only speculation.
However, there is tremendous evidence that mandatory RIK
would lose revenue. Loss estimates range from $140 to $360
million annually, according to MMS. Under H.R. 3334, the
Federal Government would be required to accept all oil and gas
as a payment in kind. This means that the government would
receive some oil and gas at less than marketable conditions as
well as small volumes of production in remote locations, where
it would be subject to high transportation costs. Furthermore,
the bill calls for taxpayers to assume new costs that they do
not have to pay for currently, such as marketing. These factors
are likely to cost taxpayers hundreds of millions of dollars
per year, according to MMS, leading the agency to conclude that
H.R. 3334 is ``primarily designed to enhance the interests of
oil and gas producers, at the expense of the American
taxpayer.''
C. SPECIFIC EXAMPLES OF HOW H.R 3334 IS RIGGED AGAINST
TAXPAYERS
Section 4 (a) will require the government to pay to remove
impurities, such as carbon dioxide, from the oil or gas.
Currently, the government does not pay these costs.
Section 4 (b) of the bill will require the government to
pay transportation costs for non-royalty bearing substances.
For example, in some wells in the Gulf of Mexico, oil is
shipped with as much as 40 percent water by volume. Currently
the government does not pay such costs.
II. CHANGE NOT JUSTIFIED
A. MMS HAS STATUTORY AUTHORITY TO ACCEPT RIK
Under current law, MMS already has statutory authority to
accept RIK payments--legislative changes are not necessary. In
cases where it makes sense, MMS can already accept RIK. In
other cases, MMS can choose cash payment.
B. ADMINISTRATIVE SAVINGS WOULD BE OVERWHELMED BY NEW BURDEN
Supporters of H.R. 3334 claim that RIK will reduce costs
and eliminate bureaucratic burdens, possibly allowing for MMS
staff to be reduced. MMS may deserve some of the criticism it
receives and may need to have its bureaucracy trimmed. But the
small cuts RIK may allow for in MMS's $63 million royalty
collection budget are not worth risking the $4 to $5 billion in
royalties the current system generates annually. In a 1995 gas
marketing pilot program, MMS reported substantial royalty
losses which ``overwhelmed small administrative savings,''
according to MMS Director Cynthia Quarteman's testimony.
Even the possibility that mandatory RIK would allow for
MMS's budget to be significantly cut is unrealistic. Auditors
would still be needed. In addition, with the new burdens of
sale and marketing placed on MMS or some other agency,
bureaucracy is likely to increase not decrease.
C. PROPOSED NEW RULE FIXES MANY PROBLEMS
Basing oil royalties on posted prices--as is currently
done--has been fraught with problems for both taxpayers.
However, MMS's proposed new rules will minimize many of these
problems by relying more on market mechanisms such as published
market prices for the major oil companies. Second, the proposed
rules are supported by the many lawsuits against the oil
companies for underpayment of royalties. In the current False
Claims Act case against 4 major oil companies, intervention by
the Justice Department indicated that there is evidence of
systematic underpayment of oil and gas royalties.
MMS's proposed rule will not only assure true market value
for the taxpayer's oil, but will provide the certainty, through
widely available published prices, to end much of costly audit
and litigation burden on both industry and government. H.R.
3334 is not needed, and can not reduce this burden as
effectively as the proposed rule. As a plaintiff in the False
Claims Act case, a self-described oil and gas industry man for
50 years put the issue: ``it simply is a matter of living up to
formal agreements made to lease government lands.'' Industry
need not and should not be asked to pay one cent more than it
owes, but it can and should pay what is required under the
terms of its current leases.
III. CREATES AN UNNEEDED NEW PROGRAM
H.R. 3334 would require the creation of an unneeded Federal
program in conflict with current efforts to reduce the size of
government bureaucracy and get the government out of
inappropriate roles. Bureaucracy would expand in order to
market and sell large quantities of oil and gas. Additional
employees would be required to figure out how to maximize
government profit, market the plan, and sell the assets.
Furthermore, advertising, marketing, and selling a market
product are not traditionally U.S. Government roles, nor
something it usually does well. There are cases where the
government can and should act more like a business, but in this
instance the government does not need to mimic private
business, because private businesses already market and sell
oil and gas reasonably well. Even if the government contracts
out some aspects of marketing and sales, it would still be
substantially involved in new aspects of the industry and would
have to increase administrative costs to oversee and implement
it.
Finally, increased government competition with oil and gas
companies could be problematic. General revenues might somehow
be used to subsidize the government marketing and sales team,
enabling the government to undercut private industry. Or, if
the government was able to use its size and ability to combine
large supplies of oil and gas to assert market power--as H.R.
3334 supporters urge--industry could rightly complain that the
government was unfairly competing. Private utilities complain
that their competitors, Power Marketing Administrations (PMAs)
and rural coops, receive an unfair leverage through Federal
subsidies and other advantages. As Ward Uggerud, Otter Tail
Power Company Vice President, argued before Congress in 1996,
``The PMAs are unregulated monopolies that are pursuing
monopoly practices in the marketplace.'' We do not need to
recreate this type of problem in the oil and gas industry.
At a time when the Federal Government is pulling out of
functions that private industry is able to well serve, this new
Federal role makes even less sense. Congress has recognized
that the Federal bureaucracy no longer needs to be in the
business of helping sell tea and may other market commodities.
The 104th Congress finally killed the almost 100 year old Board
of Tea Experts whose job it was to touch, sniff, and taste
samples of imported tea to test their purity, quality, and
fitness. We have just sold off the Elk Hills Naval Petroleum
Reserve, primarily as the industry proponents argued, because
the government should get out of the oil business. Now the
industry is telling the government it has to get back in the
oil business. H.R. 3334 is clearly a step in the wrong
direction and reverses progress made in killing unnecessary and
outdated government programs.
IV. EXAMPLE OF PROBLEMS
To illustrate many of the problems with this legislation,
allow me to construct this slightly silly scenario. Let's
pretend I owe $10 to each of the members of this Committee. But
what if instead of cash, I offer you a can of gasoline instead.
For some of you this might be a good deal. You noticed you were
low on gas this morning and could use the can to fill up your
tank. Others of you might even be able make a profit because
you remember that a friend ran out of gas this morning and
would be willing to pay top dollar for delivery of gas.
However, others of you would much rather have the cash.
Possibly you walked to work and would be stuck lugging a heavy
can home. Or maybe you do not want the hassle of trying to sell
gas and think that the gas station down the street would not
give you a good price. All of you would better off if you have
a choice between the cash and the gas.
Likewise, taxpayers are better served by reserving the
right to choose between cash payments and RIK as they do under
the current system. By rejecting H.R. 3334 and any similar
bills, this Committee can preserve that choice and ensure that
taxpayers receive the royalties they deserve.
Thank you.
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