<DOC>
[110 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:40641.wais]
S. Hrg. 110-326
OVERSIGHT OF THE OUTER CONTINENTAL SHELF OIL AND NATURAL GAS ROYALTY
MANAGEMENT
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HEARING
before a
SUBCOMMITTEE OF THE
COMMITTEE ON APPROPRIATIONS UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
SPECIAL HEARING
FEBRUARY 13, 2007--WASHINGTON, DC
__________
Printed for the use of the Committee on Appropriations
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
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__________
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COMMITTEE ON APPROPRIATIONS
ROBERT C. BYRD, West Virginia, Chairman
DANIEL K. INOUYE, Hawaii THAD COCHRAN, Mississippi
PATRICK J. LEAHY, Vermont TED STEVENS, Alaska
TOM HARKIN, Iowa ARLEN SPECTER, Pennsylvania
BARBARA A. MIKULSKI, Maryland PETE V. DOMENICI, New Mexico
HERB KOHL, Wisconsin CHRISTOPHER S. BOND, Missouri
PATTY MURRAY, Washington MITCH McCONNELL, Kentucky
BYRON L. DORGAN, North Dakota RICHARD C. SHELBY, Alabama
DIANNE FEINSTEIN, California JUDD GREGG, New Hampshire
RICHARD J. DURBIN, Illinois ROBERT F. BENNETT, Utah
TIM JOHNSON, South Dakota LARRY CRAIG, Idaho
MARY L. LANDRIEU, Louisiana KAY BAILEY HUTCHISON, Texas
JACK REED, Rhode Island SAM BROWNBACK, Kansas
FRANK R. LAUTENBERG, New Jersey WAYNE ALLARD, Colorado
BEN NELSON, Nebraska LAMAR ALEXANDER, Tennessee
Charles Kieffer, Staff Director
Bruce Evans, Minority Staff Director
------
Subcommittee on Department of the Interior, Environment, and Related
Agenics
DIANNE FEINSTEIN, California, Chairman
ROBERT C. BYRD, West Virginia WAYNE ALLARD, Colorado
PATRICK J. LEAHY, Vermont LARRY CRAIG, Idaho
BYRON L. DORGAN, North Dakota TED STEVENS, Alaska
BARBARA A. MIKULSKI, Maryland THAD COCHRAN, Mississippi
HERB KOHL, Wisconsin PETE V. DOMENICI, New Mexico
TIM JOHNSON, South Dakota ROBERT F. BENNETT, Utah
JACK REED, Rhode Island JUDD GREGG, New Hampshire
BEN NELSON, Nebraska LAMAR ALEXANDER, Tennessee
Professional Staff
Peter Kiefhaber
Ginny James
Rachel Taylor
Scott Dalzell
Chris Watkins
Leif Fonnesbeck (Minority)
Rebecca Benn (Minority)
Calli Daly (Minority)
Administrative Support
Katie Batte (Minority)
C O N T E N T S
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Page
Opening statement of Senator Dianne Feinstein.................... 1
Statement of Hon. C. Stephen Allred, Assistant Secretary, Land
and Minerals Management, Department of the Interior............ 2
Prepared statement........................................... 5
Statement of Senator Lamar Alexander............................. 13
Statement of Senator Pete V. Domenici............................ 17
OVERSIGHT OF THE OUTER CONTINENTAL SHELF OIL AND NATURAL GAS ROYALTY
MANAGEMENT
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TUESDAY, FEBRUARY 13, 2007
U.S. Senate,
Subcommittee on Department of the Interior,
Environment, and Related Agencies,
Committee on Appropriations,
Washington, DC.
The subcommittee met at 10:02 a.m., in room SD-124, Dirksen
Senate Office Building, Hon. Dianne Feinstein (chairman)
presiding.
Present: Senators Feinstein, Reed, Craig, Domenici, and
Alexander.
opening statement of senator dianne feinstein
Senator Feinstein. The meeting of the Interior
Appropriations Subcommittee will come to order. Senator Craig
is unavoidably delayed for a few minutes, but he will be along
soon and has asked that we proceed ahead. I know there are
meetings of other committees, so we might be short of members
this morning, but I am delighted to see Senator Alexander here.
Welcome, Senator. Great to have you here.
This morning the subcommittee will hear from Stephen
Allred, the Interior Department's Assistant Secretary for Land
and Minerals Management. As the administration's designated
point man on the royalty relief issue, Mr. Allred is here this
morning to shed light on what is being done to recoup the
billions of dollars lost to the Treasury as a result of the
flawed 1998-1999 offshore oil and gas leases.
Through bureaucratic oversight, the Department of the
Interior issued offshore oil and gas leases in 1998 and 1999
that did not include the necessary royalty price threshold
language. The companies holding the leases have taken advantage
of the oversight to avoid paying royalties, while at the same
time reaping record profits. These companies know the
Government does not give away drilling rights for free, but
most of them have decided to stick to their position. As a
result, they have deprived the American taxpayer of $1 billion
thus far and may deprive the taxpayer of another $9 billion
before the 1998-1999 leases expire.
This should bother all of us on this subcommittee. No
company should be allowed to earn enormous profits off the
resources taken from publicly owned land and water without
paying back a fair return to the taxpayer.
Mr. Allred, I know you are not personally responsible for
the fact that the Minerals Management Service signed leases
with oil and gas companies that essentially gave away $10
billion in royalty payments that were due the taxpayer. But you
have nevertheless been delegated the unenviable task of
resolving this problem. I want to assure you that I am ready to
work with this administration to see that this enormous leak on
the Nation's finances is plugged.
We are gratified that you have been able to reach agreement
with six companies to renegotiate their leases and pay
royalties on their oil and gas revenues. That is a very
important first step. But more needs to be done and I believe
it is up to Congress to provide an additional stimulus.
As you know, Mr. Allred, I proposed legislation that would
require Secretary Kempthorne to enter into good faith
negotiations over the 1998-1999 leases and deny a new lease to
any company refusing to negotiate. I also look forward to
exploring an additional idea with you that may in fact bring in
the lion's share of what is still outstanding.
Finally, I want to note that recently President Bush
decided to open new areas in the Gulf and Alaska to deep water
exploration. I am concerned about the ecological safety of
additional offshore oil drilling. According to your own agency
data, 113 platforms were destroyed and another 52 were
extensively damaged by Hurricanes Katrina and Rita. One oil
pipeline was moved 5,000 feet by Hurricane Rita. I hope you
will be able to shed some light on the extent of ecological
damages from oil spills during these hurricanes.
I note that Senator Craig has not yet come, but what we
will do when he comes, if it is agreeable, we will proceed with
your presentation and perhaps interrupt you if necessary to
hear from the ranking member.
We are also joined by Senator Reed. Delighted to have you
here this morning.
The rule we will use will be the early bird rule modified
by party. So we will do early bird, but go back and forth so
that one side just cannot stack the deck, so to speak.
So we are delighted to have you here, Mr. Allred, and
unless members have a statement that they like to make we will
proceed with your statement.
STATEMENT OF HON. C. STEPHEN ALLRED, ASSISTANT
SECRETARY, LAND AND MINERALS MANAGEMENT,
DEPARTMENT OF THE INTERIOR
Mr. Allred. Thank you very much, Madam Chairman, Senator
Alexander, Senator Reed. It is a pleasure to be here and I
appreciate the opportunity to meet with you today to discuss
our ongoing work as we address the absence of the price
thresholds in the deep water leases that were issued in 1998
and 1999 in the Gulf of Mexico.
At the outset, let me state my belief that our Government
employees have an obligation to protect the public interest of
the United States and they must be perceived as doing so. If
the public believes that we have somehow failed in this
obligation, whether it is in fact or perception, the damage
operates to the detriment of all of us.
What I want to do in the next couple of minutes is just to
allow you the maximum time for your questions, is to tell you
what the Secretary and I are doing to deal with the issues that
are the subject of this hearing. After the Senate confirmed me
as Assistant Secretary some 4 months ago, Senator Kempthorne
asked me, as you indicated, to review and manage the issues
that were involved in the 1998 and 1999 leases and to deal with
other royalty matters that were of concern.
As you know, he places great importance on the Department,
its agencies, and its employees acting in a highly ethical
manner, again both in fact and in perception. The Department
has reviewed the Inspector General's report concerning the 1998
and 1999 leases and the collection of oil and gas revenues. In
addition, I have traveled to the Minerals Management Service
Denver operations office, which is responsible for collecting
the revenues that are due the United States, the States, and
Indian tribes, and I have been thoroughly briefed and reviewed
their processes.
I have also traveled to the New Orleans Regional Office,
which is the office in MMS that is responsible for both issuing
the leases and managing those leases and in regulating the
operations of the oil companies on the OCS.
We have also formed, as you probably are aware, a high-
level review panel that will look at how we collect revenues to
make sure that we have the input of an outside group as to how
we can improve our operations. We hope to complete the
selection of the panel members in the near future so that we
can officially announce the membership of that panel.
I would like to say, though, that, in my opinion and after
my review, I believe that we are collecting the revenues that
are due the United States, the States and the Tribes. However,
with any large organization with complex operations, there are
many opportunities to improve our operations and we look
forward to doing that as we go forward.
Now with regard to the absence of price thresholds in the
1998 and 1999 leases. We are reviewing the Inspector General's
report, which we asked for, to review or to gain a more
complete understanding of what happened in 1998 and 1999. When
that review is fully complete, I have asked the Minerals
Management Service to form a group, including a member of the
Inspector General's staff, to conduct a lessons-learned review
to apply these lessons to our ongoing leasing activities.
As you are aware, since 2001 the Department of the Interior
has made certain that price thresholds have been included as
part of any royalty relief granted under the Deep Water Royalty
Relief Act that Congress has enacted. I have discussed this
issue with most of the companies who hold these leases and in
these discussions, I have had three guiding principles:
First, there is a valid contract between the United States
and the companies.
Second, my goal in these discussions has been to focus on
the greatest amount of royalties available, those which will be
derived from future production.
Third, and this is one I will talk about a little bit
further, I have sought to minimize to the extent possible the
opportunities for legal challenges to this process, the
processes that we will follow.
As you indicated, Madam Chairman, we have been successful
in negotiating amendments with six of the companies that have
those leases. We have continuing discussions with the rest of
the companies. However, I believe that we will not make further
progress until Congress has decided and defined the role that
it chooses to play in this issue.
It is clear that our Nation's demand for oil and gas will
continue to grow and that a significant portion of that supply
will continue to come from the Gulf of Mexico. Madam Chairman,
members of the committee, I have a chart up on the board and,
while it is probably too far away to see--and you,
incidentally, have a copy of these--I think what is important
to look at is that top red line. That top red line indicates
what the Energy Information Agency believes will continue to
happen with the growth in the demand for energy in the United
States. You will also, as you get a chance to look at that
chart in more detail, see that that is in spite of a
significant increase in renewables and alternative energy
sources.
As you can see from that chart, the demand for oil has
risen steadily and is projected to continue. The Gulf of Mexico
is where a significant portion of that U.S. production occurs
and will continue to occur. Given these trends, I am
particularly concerned that as you and we go forward to address
the missing price thresholds, that we do it in a way that will
not result in unintended consequences that might otherwise
disrupt the ability to supply the Nation's continuing energy
needs.
Specifically, I am concerned as we decide what to do that
we not provide an opportunity for a company that has entered
into the leases with the Federal Government to be disadvantaged
in such a way that they might convince a court to enjoin all
future lease sales in the Gulf of Mexico until the matter is
resolved. The impacts of such an action that the courts might
take I think cannot be overstated.
I have two graphs here I would like to show you. The first
indicates that if we were enjoined from issuing further leases,
beginning with the sales that will occur this fall, what the
effect would be on production in the gulf. The production
delays over a 10-year period that could result in such a
challenge and such an injunction for a period of 3 years would
be some 1.6 billion barrels of oil, and that certainly would
have a ripple effect through our economy.
Equally profound, I think to this committee particularly,
would be the cumulative revenue impacts to the U.S. Treasury.
Again, from a 3-year delay in leasing programs, which is what I
think it might take to resolve it through the Supreme Court,
the Treasury could lose some $13 billion over a 10-year period.
prepared statement
These are difficult issues and are not going to be easily
resolved. Nevertheless, I believe that we and Congress are
making progress and we will continue to do so in concert with
this committee and other committees.
Madam Chairman, I stand ready to work with you to address
these challenges as we move forward and I would be most happy
to answer questions from yourself or from the committee.
[The statement follows:]
Prepared Statement of Hon. C. Stephen Allred
Chairman Feinstein, thank you for the opportunity to appear here
today to discuss with you the Department of the Interior's role in
managing energy production on the Outer Continental Shelf and revenue
from all Federal and Indian mineral leases. This Committee has been
instrumental in shaping our domestic energy program, particularly with
regard to encouraging environmentally sound development of our domestic
oil and gas resources on the Outer Continental Shelf.
The Department and its agencies, including the Minerals Management
Service (MMS), serve the public through careful stewardship of our
nation's natural resources. The Department also plays an important role
in domestic energy development. One third of all energy produced in the
United States comes from resources managed by the Interior Department.
As energy demand continues to increase, these resources are all the
more important to our national security and to our economy. The Energy
Information Administration estimates that, despite increased
efficiencies and conservation, over the next 20 years energy
consumption is expected to grow more than 25 percent. Even with more
renewable energy production expected, oil and natural gas will continue
to account for a majority of energy use through 2030. Interior's
domestic energy programs, particularly offshore oil and gas production,
will remain vital to our national energy portfolio for some time to
come, as evidenced in Figure A attached at the end of my statement.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Since assuming the duties of Assistant Secretary of Land and
Minerals Management four months ago, I have developed a deeper
appreciation for the complexities involved in managing Federal energy
production. I also am committed to ensuring we provide an accurate and
transparent accounting of the revenue this production generates for the
American people.
At the direction of Secretary Kempthorne, two important topics have
been my major focus over the past 4 months--the deep water leases
issued without price thresholds for royalty relief in 1998 and 1999,
and the management of royalty revenues.
I would like to begin by providing some background on MMS's role in
Federal energy production and revenue collection. I then will discuss
in greater detail the two primary issues I am focusing on with MMS.
mms background
The MMS has two significant missions: managing access to offshore
Federal energy resources and managing revenues generated by Federal and
Indian mineral leases, on and offshore. Both of these functions are
important to the Nation's economic health and are key to meeting the
Nation's energy needs.
The Federal Outer Continental Shelf (OCS) covers 1.76 billion acres
and is a major source of crude oil and natural gas for the domestic
market. In fact, according to the Energy Information Administration, if
the Federal OCS were treated as a separate country, it would rank among
the top five nations in the world in terms of the amount of crude oil
and second in natural gas it supplies for annual U.S. consumption.\1\
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\1\ EIA U.S. Imports by Country of Origin, 12-21-2006.
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Since 1982, MMS has overseen OCS production of almost 11 billion
barrels of oil and 116 trillion cubic feet of natural gas.
According to MMS's calculations, within the next 5 years, offshore
production will likely account for more than 40 percent of oil and 20
percent of U.S. natural gas production, primarily due to deep water
discoveries in the Gulf of Mexico.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Attached Figure B shows the Energy Information Administration's
2007 forecast for total domestic oil and gas production and illustrates
the significance of the OCS contribution to the Nation's energy
security.
To support increased production offshore, MMS's Proposed 5-Year OCS
Oil and Gas Leasing Program for 2007-2012 calls for a total of 21 lease
sales.
Last month, the President modified a Presidential withdrawal in
order to allow leasing in two areas previously closed--the North
Aleutian Basin in Alaska and an area in the central Gulf of Mexico. The
President modified the leasing status of these two areas in response to
congressional action and the request of Alaska State leaders. The
President's action allows the Secretary of the Interior the option of
offering these areas during MMS's next 5-year OCS oil and gas leasing
program. In addition, this administration has increased the royalty
rate from 12.5 percent to 16.7 percent for any new deep water leases
offered in the Gulf of Mexico.
In implementing the mandates of the Gulf of Mexico Energy Security
Act, MMS will offer deep water acreage in the ``181 South'' area and in
a portion of the Sale 181 area remaining in the Eastern Gulf of Mexico.
Our analysis indicates that implementing the new 5-Year OCS Oil and
Gas Leasing Program would result in a mean estimate of an additional 10
billion barrels of oil, 45 trillion cubic feet of gas, and $170 billion
in net benefits for the nation over a 40-year time span.
In addition to providing and managing access to the OCS, MMS
administers and enforces the financial terms for all Federal mineral
leases, both onshore and offshore and on Indian lands.
These activities have generated an average of more than $9 billion
in revenue per year over the past 5 years, representing one of the
largest sources of non-tax revenue to the Federal Government. (In
fiscal year 2006, $12.6 billion was collected and $12.8 billion was
disbursed, 60 percent of that was from offshore activities).
Since 1982, the MMS has distributed approximately $164.9 billion to
Federal, State, and Indian accounts and special funds, including
approximately:
--$101.1 billion to the General Fund of the U.S. Treasury;
--$20.4 billion to 38 States;
--$5.2 billion to the Department's Office of Trust Funds Management
on behalf of 41 Indian tribes and 30,000 individual Indian
mineral owners; and
--$38.2 billion to the Land and Water Conservation Fund, the National
Historic Preservation Fund, and the Reclamation Fund.
MMS carries out these responsibilities under statutory mandates and
ongoing oversight by Congress, the Government Accountability Office
(GAO) and the Department's Office of Inspector General.
I am happy to point out that for the past 5 years, as part of its
annual CFO audit, MMS consistently has received clean audit opinions
from the Office of the Inspector General and its delegated independent
auditing firm.
1998-1999 ocs leases without price thresholds for royalty relief
Last month, the Department's Office of Inspector General presented
its findings on the 1998-1999 deep water leases issued without price
thresholds. The MMS requested this independent review last year. We
appreciate the Inspector General's work and look forward to further
reviewing the report.
The Department of the Interior shares Congress's frustration that
during the previous Administration price thresholds were not included
in the 1998-1999 deep water leases. This administration has included
price thresholds in all deep water leases it has issued with royalty
relief. The American people own these resources and are entitled to
receive a fair return.
The Deep Water Royalty Relief Act of 1995 required deep water
leases issued from 1996-2000 to include a royalty incentive that
allowed companies to produce a set volume of oil and gas before they
began paying royalties. Since enactment, the deep waters of the Gulf of
Mexico have become one of the Nation's most important sources of oil
and natural gas. Price thresholds limit royalty relief when oil and gas
prices are high. Price thresholds were included in leases before 1998
and after 1999. They were not included in the 1998-1999 leases.
This matter has been a focus of mine since I assumed this position
last fall. In an attempt to address the missing price thresholds, we
are now negotiating with companies to obtain agreements to apply price
thresholds to the deep water leases issued in 1998-1999. We are
focusing our negotiations on obtaining the much larger royalty amounts
to be realized from future production, estimated to exceed $9 billion.
To date our progress has included agreements reached in December
2006 with six companies. This is a significant but first step; there is
still much more work to do in reaching agreements with additional
companies.
I have adopted three basic principles to guide my actions in
seeking to resolve this matter. First, our focus will be to negotiate
price thresholds in leases prospectively; second, we will not give
economic advantage to one company over another; and finally, we will
strive to amend these agreements in a way that will minimize litigation
risk.
To achieve these principles, the administration and the Congress
must work together. We cannot do this alone.
We know that Congress will consider addressing this issue
legislatively. We appreciate Congress's efforts to encourage companies
to come to the negotiating table. However, we must be mindful of
potential unintended consequences. For example, potential new
legislation could conceivably result in litigation. If legislation
addressed future lease sales, and if a judge were to enjoin future
lease issuance for a period of time, the resulting impacts would be
significant. Litigation could take years to resolve. The MMS has
attempted to project what the potential loss of production, revenue and
royalties if lease sales were delayed for a 3-year period could look
like.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Attached Figure C shows for example, for a 3-year delay, production
over 10 years would be reduced 1.6 billion barrels of oil equivalent
(boe).
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Attached Figure D shows for example, the expected cumulative
revenue decline over a 10 year period of $13 billion for a 3-year
delay.
We all can agree this would not be in the Nation's best interest.
The OCS is a significant supplier of oil and gas. We cannot afford
major delays in offshore energy production due to unintended
consequences.
We look forward to working with Congress on resolving this issue of
national interest.
management of royalty revenue
My second focus is the management of royalty revenue collected from
Federal and Indian mineral leases. In fiscal year 2006, about 2,600
companies reported and paid royalties totaling $12.6 billion from
approximately 27,800 producing Federal and Indian leases.
MMS's mineral revenue processes and procedures are complex and
involve implementing myriad statutory authorities and regulations, as
well as a complex set of case law from over 50 years of administrative
and judicial decisions on Federal royalty matters.
The process begins when companies calculate their payments for
royalties owed the Federal Government. Royalties are calculated based
upon four components: the volume of oil and gas produced from the
lease, which is verified by BLM or MMS officials during regular on-site
inspections; the royalty rate, which is specified in the lease
document; the value of the oil and gas as determined by regulations;
and any deductions for the costs of transporting and/or processing the
oil and gas production, which are also determined by regulations.
Companies are required to report this information and submit their
royalty payments to MMS on a monthly basis.
MMS receives reports and payments from payors and accepts them into
the accounting system, similar to filings with the Internal Revenue
Service. Fundamental accounting processes identify revenue sources, and
funds are distributed to recipients as prescribed by law. Interest is
assessed on late and/or under payments.
MMS's audit and compliance program assesses whether royalty
payments are correct. The types of questions that arise during
compliance activities include whether the company reported and paid its
royalty on the right volume, royalty rate, and value and whether the
company correctly calculated allowable transportation and processing
costs. Findings of underpayments are followed by collection of the
payment plus interest. Enforcement proceedings range from alternative
dispute resolution to orders to pay and penalty actions.
The current compliance strategy uses a combination of targeted and
random audits, compliance reviews, and royalty-in-kind property
reconciliations. The strategy calls for completion of the compliance
cycle within 3 years of the royalty due date. In fiscal year 2006, this
strategy resulted in compliance activities on $5.8 billion in Federal
and Indian mineral lease revenues, which represents 72.5 percent of
total mineral revenues paid for calendar year 2003. As a result of the
December 6, 2006 Office of the Inspector General report, MMS will be
developing a new risk strategy and performance targets that reflect the
number of companies and/or leases covered, not total royalties. In
addition, as RIK gas volumes expand, MMS expects offshore compliance
workloads to decrease, freeing up resources to be redirected toward
highest risk, but smaller-dollar onshore Federal properties.
In recent years, MMS has completed an increased number of audits,
doubling the number of audits in the most recent 4-year period over the
previous 4 years. From 1998-2001, MMS, State, and Tribal auditors
completed 784 audits compared to the 1,572 audits completed from 2002-
2005. This increase is partially the result of the effort in 2005 on
the part of MMS to close a significant number of old audits as a result
of a recommendation from an external peer review of our audit
activities. Collections based on audit work fluctuate from year to
year. The apparent reductions in collections resulting from compliance
efforts from 2001 through 2004 stand in contrast with very large
collections in the 1998-2001 period. This anomaly is due to resolution
during the 1998-2001 period of numerous lawsuits on undervaluation of
crude oil and natural gas in previous years The result of the
resolution of these issues was large payments of additional royalties.
Because these issues were resolved, no additional large payments were
owed in 2002-2005.
The MMS compliance and enforcement program has generated an annual
average of more than $125 million for each of the last 24 years. In
other words, MMS has collected a total of more than $3 billion dollars
in additional mineral revenues since program inception in 1982.
From fiscal year 2003 through fiscal year 2005, for every dollar
spent on compliance reviews, MMS has collected $3.27. For every dollar
spent on audits, MMS has collected $2.06.
MMS aggressively pursues interest owed on late payments as required
by law. In fiscal year 2006, MMS issued over 3,800 late payment
interest bills and collected a net amount of $7 million.
MMS has authority to use civil penalties in situations where
routine compliance efforts have been unsuccessful. During the last 5
years MMS has collected over $23 million in civil penalties resulting
from MRM enforcement actions. So far in fiscal year 2007 MMS has issued
over $2 million in civil penalty notices that are now in the
administrative process. When combined with other MMS enforcement
actions during the same time frame, MMS collected a total of $52.4
million.
Last year, the MMS while performing reconciliation of volume
imbalances, promptly identified that the Kerr McGee Oil and Gas
Corporation had under-delivered royalty gas volumes to MMS's Royalty-
In-Kind (RIK) program--at a time of very high gas prices. MMS pursued
the issue and collected $8.1 million--based on these high price
periods--to resolve the issue.
In December, MMS announced that a bill for over $32 million had
been issued to BP America Production Company for additional royalties
and interest due identified through audit work of BP's coalbed methane
production that occurred in the State of New Mexico.
These day-to-day efforts are just part of MMS's normal course of
business. These efforts are not only effective at ensuring compliance,
but also beneficial in bringing the appropriate revenues to the States,
Indians, and the American public.
I would like to emphasize, however, that although this work is
important, our focus is not on numbers of audits or amounts obtained in
collections. The real goal is to increase upfront voluntary compliance.
We measure success in having higher levels of upfront compliance so
that companies make correct payments the first time. Audits act as a
deterrent, but we hope that audits will reveal fewer problems as
companies become more proficient in calculating and paying the
royalties they owe accurately.
MMS has taken steps to improve compliance rates in order to achieve
this goal. They include the following:
--Clearer Regulations.--MMS has made significant progress in
developing and implementing clearer regulations, eliminating
much uncertainty and ambiguity that previously resulted in
major findings.
--Royalty-In-Kind (RIK).--MMS is receiving an increasing percentage
of revenues through its RIK program and has eliminated many
valuation issues for the RIK volumes. During fiscal year 2006,
for example, MMS received about one-third of its revenues
through RIK.
--More Effective Compliance Strategies--Compliance reviews have
allowed MMS to cover more properties than were possible using
audits alone, thereby increasing the deterrent effect. This
increased presence encourages companies to be more vigilant
about proper reporting and payment.
We appreciate the recent report of the Office of Inspector General
concerning the audit and compliance program. The results are similar in
substance to audits I have reviewed in State government or in the
private sector. My experience is that in any organization with such
large and complex operations, I would expect any performance audit to
find opportunities for improvement. MMS has embraced virtually all of
the findings, and has an action plan to address them.
We note the Inspector General's major conclusion that compliance
reviews are a useful tool in our program, and we look forward to
implementing recommendations to further improve our application of
compliance reviews. We submit for the Committee's attention our
``Action Plan to Strengthen Minerals Management Service's Compliance
Program Operations'' which documents improvement actions taken and
planned in this area.
MMS does not work alone in its efforts to ensure the proper
collection of royalties; MMS collaborates with the States and tribes on
our compliance and audit activities. In addition, every three years,
the Federal audit function of MMS is peer-reviewed by an outside
independent certified public accounting firm. Most recently, in 2005,
the MMS audit program was found to meet all applicable government
auditing standards. As noted earlier, for the past five years, as part
of its annual Chief Financial Officer audit, MMS consistently has
received clean audit opinions from the Office of the Inspector General
and its delegated independent auditing firm.
Having said that, it is also true that MMS continues to look for
ways to improve its programs, practices and performance. We welcome
input from this Committee, the full Congress, the Office of the
Inspector General, GAO and the public.
In response to the recent interest regarding the accuracy and
effectiveness of the MMS's royalty management program, Secretary
Kempthorne and I determined that an independent panel should be
convened to review the procedures and processes surrounding MMS's
management of mineral revenue. We are committed to ensuring our
processes are effective and transparent, and we welcome advice and
counsel.
The new panel will operate as a subcommittee under the auspices of
the Royalty Policy Committee, an independent advisory board appointed
by the Interior Secretary to advise on royalty management issues and
other mineral-related policies.
The Subcommittee on Royalty Management has been asked to review
prospectively:
--The extent to which existing procedures and processes for reporting
and accounting for Federal and Indian mineral revenues are
sufficient to ensure that the MMS receives the correct amount.
--The audit, compliance and enforcement procedures and processes of
the MMS to determine if they are adequate to ensure that
mineral companies are complying with existing statutes, lease
terms, and regulations as they pertain to payment of royalties.
--The operations of the Royalty-in-Kind program to ensure that
adequate policies, procedures and controls are in place to
ensure that decisions to take Federal oil and gas royalties in
kind result in net benefits to the American people.
The subcommittee will conduct its review over a 6-month period and
then provide its final findings and recommendations to the full Royalty
Policy Committee and the Secretary of the Interior. We will be happy to
share the recommendations with you when they are available.
Members of the subcommittee will be announced in the near future.
strategic petroleum reserve
During the State of the Union Address, President Bush announced
plans to double our nation's Strategic Petroleum Reserve (SPR) to 1.5
billion barrels of oil. Also announced was a directive to fill the SPR
to its current capacity of 727 million barrels. MMS will provide
royalty in kind oil starting in July 2007 to accomplish this mandate.
This policy decision will provide an additional layer of protection for
our nation's energy security.
fiscal year 2008 president's budget request
For fiscal year 2008, MMS has submitted a budget request of $297
million in current appropriations and offsetting receipts which is an
overall increase of $5 million from the fiscal year 2007 President's
Budget (an additional $16 million relative to the 2007 Continuing
Resolution that is currently in place). The additional funds requested
in the President's Budget will improve MMS' ability to: implement the
5-Year Oil & Gas Leasing Program (2007-2012); provide oversight of
increasing ultra-deepwater offshore development; hire specialized staff
to address well abandonment and pollution prevention issues in the Gulf
of Mexico region; and fully fund projected fixed cost increases for
personnel-related costs and rent.
In addition to the items listed above, the President's Budget also
includes additional funding for two systems changes that are designed
to enhance compliance and enforcement efforts in the management of
mineral revenues. The budget includes $940,000 for an adjustment line
monitoring initiative for MRM Support System modifications to ensure
that company reporting adjustments are made only within allowable
timeframes. The budget also includes $1.45 million for the first year
of a two-year interactive payment reconciliation and billing
initiative, which will allow MMS to automate the interface with its
customer base on numerous activities. Both of these proposals provide a
strong return on investment and will provide MMS with the resources
necessary to continue to improve its robust audit and compliance
program.
conclusion
In the four months since I was confirmed to this position, I have
been working closely with the MMS to understand the complex processes
associated with accounting for the revenues generated from oil and gas
development on Federal lands, including the Outer Continental Shelf. In
an effort to gain a greater understanding of this work, in early
January I traveled to MMS's Denver Office where I reviewed the
procedures and controls used to ensure that minerals revenues are
properly reported and accounted for. I also visited offices and
reviewed operations in the Gulf of Mexico Regional Office.
This work is very important and must be undertaken carefully.
Equally important, and very important to Secretary Kempthorne and me,
is that we conduct business with the highest standards of ethics
possible. Making sure we can live up to that standard has been a high
priority of mine. I have stressed, and will continue to stress, our
obligation to conduct ourselves in accordance with the highest ethical
standards and to be accountable for our actions. Moreover, our conduct
must be ethical both in fact as well as in perception.
To summarize my remarks today, I want to reiterate I will continue
to focus on several key areas as I provide oversight to the Minerals
Management Service.
We will issue our 5-year proposed OCS leasing program on time. This
is an important plan that addresses national energy security and
facilitates the development of critical energy resources now and in the
future.
I will continue to seek prospective royalty agreements with the
companies that entered into leases issued in 1998 and 1999 that lack
price thresholds in order to capture the majority of the revenues the
government would have received.
I am pleased at the results of our efforts thus far, but recognize
that there is much more work to be done. I look forward to continuing
to work with you, the members of Congress, to address this important
issue.
In addition, I will continue to work with MMS to review and improve
our royalty management programs. I have every confidence that MMS will
successfully implement appropriate Inspector General's recommendations
and that the review by the soon-to-be finalized Royalty Policy
Subcommittee will provide a fresh perspective on royalty management
issues and challenges.
I welcome your input on all of these initiatives, and I look
forward to working with you.
Chairman Feinstein, this concludes my remarks. I would be happy to
answer any questions you have.
1998 AND 1999 LEASE SALES
Senator Feinstein. Thank you very much, Mr. Allred.
We will have 5-minute rounds. If the staff could begin the
clock running that would be appreciated.
I am going to go rapidly through a series of questions just
to establish a record if I might, and if you could answer them
briefly I would appreciate it.
First, how much revenue was lost from 1998 to 2006 as a
result of the failure of MMS to specify price thresholds in the
1998 and 1999 lease sale contracts?
Mr. Allred. Madam Chairman, we believe that that is
approximately $900 million.
Senator Feinstein. Thank you very much, Mr. Allred.
How much more does the Government stand to lose from these
leases?
Mr. Allred. Madam Chairman, we have to make a lot of
assumptions in doing this, but in making the assumptions based
upon what we believe will be producing leases, we believe that
is about $9 billion.
Senator Feinstein. For a total then of $10 billion?
Mr. Allred. Approximately $10 billion, yes.
Senator Feinstein. Thank you.
Some of the companies have agreed to begin paying royalties
effective October 2006. Are they agreeing to pay royalties on
sales prior to last October?
Mr. Allred. Madam Chairman, in the contract amendment that
I negotiated we reserved that issue. We did not deal with it.
Senator Feinstein. So the answer is no, is that correct?
Mr. Allred. In the current signed agreements, they do not
require them to pay prior to October 1. But that is not a
resolved issue.
Senator Feinstein. Thank you.
Are the companies that voluntarily comply paying the same
royalty rates as the other leaseholders who entered into leases
since 1999?
Mr. Allred. Madam Chairman, yes, they are. Those threshold
rates are the same adjusted for inflation forward.
Senator Feinstein. Thank you.
For the record, which companies are participating and which
are not?
Mr. Allred. Madam Chairman, I am going to have to do this
from memory, but it is BP, Shell, Marathon----
Senator Feinstein. ConocoPhillips?
Mr. Allred. ConocoPhillips, and two companies of the
Walters Group, two separate companies.
Senator Feinstein. The holdouts are?
Mr. Allred. There are a number of them. If I could put up
another chart it probably would be easy to illustrate.
Senator Feinstein. I would just like, if you could, a
listing of the companies that are holdouts.
Mr. Allred. The major companies are ExxonMobil, which has a
small amount, Chevron-UNOCAL, Devon, Anadarko-Kerr McGee,
Dominion Exploration and Production, Marabeni, which is out of
Italy, Total, which is Norwegian. Then there are 32 other
companies that have each, have small amounts each, but they
total 29 percent of the estimated production.
Senator Feinstein. Thank you. Thank you. This is very
helpful.
Are foreign companies responsible for about 20 percent of
deep water oil and gas production?
Mr. Allred. Madam Chairman, the companies--one of the
things that you have to do is to have a U.S. subsidiary in
order to hold leases. But those companies which do not
otherwise operate in the United States comprise about 20
percent.
Senator Feinstein. Thank you.
Would legislation to extend the duration of the 1998-1999
leases be an incentive to the holdouts to start paying
royalties?
Mr. Allred. Madam Chairman, I believe that it would. In my
discussions--and this has not been with all of them, but just
speaking about the issue generally--I believe that that would
favorably move us forward on changing the agreements. Without
specific language, as you are aware, it is hard to get a
commitment. But I believe that that would be viewed favorably.
Senator Feinstein. Well, we are working on specific
language and we would look forward to going over that with you
if we might. That would be an extent of the leases in exchange
for a payment of the back royalties.
Mr. Allred. We look forward to working with you on it.
Senator Feinstein. Thank you very much.
My time has just about expired. I have got 6 seconds to
spare. In order of arrival, the Senators are Senator Alexander,
Senator Reed, and then Senator Domenici. Senator Alexander.
STATEMENT OF SENATOR LAMAR ALEXANDER
Senator Alexander. Thank you, Madam Chairman.
I am glad to see Senator Domenici here because I want to
talk about him. I would like to talk about a little different
subject, but it has the outer continental shelf leasing in
mind. It is something we have begun to call the Domenici one-
eighth, and I wanted to ask about the Land and Water
Conservation Fund as it relates to the legislation Congress
passed at the end of the last session, which allows for
additional drilling in what we call lease 181. Within that
there is a provision that $1 out of $8 that come in--that is
the Domenici one-eighth--would go to fund the State side of the
Land and Water Conservation Fund.
I want to talk about that and ask you a couple questions
about it. The history on this is the following. In 1965
Congress created the Land and Water Conservation Fund and
authorized funding of $450 million for the State side and $450
million for the Federal side. This was very helpful to States
and cities. The chairman is a former mayor. I am a former
Governor. We use this money for city parks, State parks,
recreation areas, usually matching it with private funds and
other funds.
The original funding for this was to come from sales of
surplus Federal real property, motorboat fuel taxes, and fees
for recreation use, but that did not amount to much, and so
Congress added a different source. In 1968 an additional source
of funding for the Land and Water Conservation Fund was to be
revenues from the outer continental shelf development. It was
to be a sort of conservation royalty. States get royalties when
you drill onshore. It goes to the State. The idea would be if
we do some drilling and we have an environmental burden maybe
we will have an environmental benefit.
In 1985 a commission which I chaired and President Reagan
appointed, called the President's Commission on Americans
Outdoors, recommended that we fully fund the Land and Water
Conservation Fund from receipts from the outer continental
shelf. That has never really happened and in the last few years
funding for the State side of the Land and Water Conservation
Fund and the Federal side has been very low.
So in light of two developments, one of which the Senator
from California was talking about and one is the Domenici one-
eighth, I am looking to see if maybe we can--and perhaps
through this subcommittee, Madam Chairman, would be a good
place to begin a discussion--move toward full funding of the
Federal side as well as the State side of the Land and Water
Conservation Fund.
So my questions would be two. One would be, do you know yet
how much money would be allocated to the State side of the Land
and Water Conservation Fund as a result of the Domenici one-
eighth, the conservation royalty that Congress enacted last
year? Second, have you considered the possibility that as we
negotiate, as you negotiate or Congress makes some decisions
about this up to $9 billion of money that should be owed to the
taxpayers, have you considered whether some of that money could
appropriately be used for the conservation royalty so that we
could see full funding of the Land and Water Conservation Fund?
Those are my two questions.
Mr. Allred. Senator, with regard to the first question, let
me ask my staff if we have a forecast. I am not aware of one.
Senator Alexander. If I do not today, could you supply the
committee with an answer to that question?
Mr. Allred. Senator Alexander, I would be glad to do that.
I think rather than giving you a number that I am not sure of,
I would just rather get it to the committee.
[The information follows:]
Gulf of Mexico Energy Security Act (GOMESA) of 2006
GOMESA authorizes 12.5 percent of certain OCS receipts (subject to
a cap in later years) to be deposited into the LWCF and made available
in the following year for the National Park Service State LWCF grant
program. Receipt projections are as follows:
[In millions of dollars]
----------------------------------------------------------------------------------------------------------------
2007 2008 2009 2010 2011 2012
----------------------------------------------------------------------------------------------------------------
GOMESA receipts for LWCF.................................. ....... 6.4 10.9 0.9 0.4 0.4
NPS LWCF Grants disbursements............................. ....... ....... 6.4 10.9 0.9 0.4
----------------------------------------------------------------------------------------------------------------
Senator Alexander. My understanding was that it would be a
low number in the early years, but it might grow to be a number
that could be as high as $80 to $100 million a year. As you
consider your answer, will you also consider, I believe 181 had
two parts to it. There was a Lease 181 and then there is some
other area which we know less about, and that might be an even
larger amount of funding that could come to the Land and Water
Conservation Fund.
What about the possibility of using this up to $9 billion,
some of that money to appropriately fund the Land and Water
Conservation Fund, as has been anticipated by Congress since
1968 and recommended by President Reagan's commission?
Mr. Allred. Senator, as you can imagine, that $9 billion
has attracted a lot of attention up here on the Hill, and we
are prepared to put it wherever you choose to put it.
Senator Alexander. Thank you, Madam Chairman.
Senator Feinstein. Thank you.
Senator Alexander. Madam Chairman, I would hope that--I
know of your long interest in these issues and I would hope
that we might have more discussions at some time about the Land
and Water Conservation Fund.
Senator Feinstein. I would look forward to that, Senator.
Thank you very much.
Senator Reed.
1998 AND 1999 LEASE SALES
Senator Reed. Thank you very much, Madam Chairman.
Thank you, Mr. Allred, for your testimony. The Secretary is
in negotiations now with these leaseholders to correct the
problem because of the contract. What leverage does he have in
that negotiation and what leverage, additional leverage, might
he use?
Mr. Allred. Senator Reed, up until this point in time I
think the leverage we have is that of the goodwill of the
companies themselves and the public pressure that they
obviously are under with regard to this issue. That is why when
asked in the Energy Committee hearing what other tools I would
need that I suggested that it would be very helpful if we had
the ability to offer these companies, based on due diligence
upon a particular lease, an extension of 3 years. I believe in
my discussions, again in very general terms, that that would
attract many of the companies.
Senator Reed. Has there been any consideration to barring
these companies from further lease activity if they fail to
negotiate?
Mr. Allred. Senator, we do not have the ability to do that.
Senator Reed. That would require legislation?
Mr. Allred. That would require legislation. What I am
concerned about, though, is the curves that I showed you
previously, that that would have to be done I think very
carefully so that we were not enjoined from issuing further
leases. That is my concern as to how we do that.
KERR-MC GEE LITIGATION
Senator Reed. Kerr-McGee is involved in litigation which
could result, according to some reports, for up to a $60
billion loss to the Treasury over 25 years. What is the
administration doing to respond to the litigation, both in
terms of trying to prevail, I presume, but also if that happens
what is the fallback position?
Mr. Allred. Senator, that issue has to do with whether or
not the act passed by Congress authorized us to put price
thresholds on. It covers a period from 1995 to 2000. So it
would have a big effect. GAO has estimated that that is like
$60 billion if they were to prevail.
We feel--our Solicitor's Office tells me and the Department
of Justice they are confident in our position. However, you and
I know judges do sometimes surprising things. We have been in
mediation in an attempt to find a way to solve it. Of course,
Kerr-McGee has been bought by Anadarko. I believe Anadarko
would like to find a way to solve this issue. At this point in
time we have not been able to do so. If we are unable to reach
any agreement, my understanding is that on March 1 the court
will then have to decide how to go forward and schedule the
court proceedings.
It is a concern to us because, again, while we feel good
about our position, courts can find however they find on these
issues dealing with authorities under legislation.
ROYALTY RATES ON DEEP WATER GULF OF MEXICO LEASES
Senator Reed. Mr. Allred, the President's budget proposes
to increase royalty rates on deep water Gulf of Mexico leases
starting in 2007 and to repeal certain provisions on deep water
gas and oil drilling. Has the Department taken a comprehensive
evaluation to determine whether the existing or proposed
royalty provisions reflect changing market conditions?
Specifically, how do they compare with rates charges by States
on State land and private landowners who are similarly selling
the same thing? Are they getting the same return on their
property?
Mr. Allred. Senator Reed, one of the reasons we changed it
was that we felt that the activities on the shelf had matured
to the point that we did not need as much incentive to get
people out there. When you looked at the early days of drilling
on the OCS, outer continental shelf, there was a high degree of
risk. No one had done it before. Fifty years ago, it was very
difficult to drill in 10 feet of water. Now we are drilling in
10,000 feet of water.
But we think there has been enough experience and enough
technology development that the lower rates are no longer
necessary. Now, as we have looked at comparing our processes
with those on State lands, State lands are--sometimes they
mimic what we do and sometimes they are more or less. But there
is a significant difference, particularly with regard to the
OCS, in that when you can drive a rig up on dry land and drill
a hole, you still have the risk of whether the resource is
there or not, but you do not have all the other risks that are
involved. That is one of the reasons why, for example, we did
not increase it in Alaska, because there still is too much
technology and too much risk there, we think, to raise that
royalty rate in those areas.
So we look at this. We try to make judgments based on
market conditions and then make a decision as to how to go
forward.
Senator Reed. Thank you, sir.
Thank you.
Senator Feinstein. Senator Craig, the ranking member, has
arrived. Senator, if you would like to make a brief statement,
then we will go to Senator Domenici if that is agreeable.
Senator Craig. Thank you very much, Madam Chairman, for
that courtesy. I wanted to get here to ask Mr. Allred a couple
of questions, but at least for the time now let me congratulate
you on becoming the chairman of this very important
subcommittee, a tremendously important subcommittee for
California, for the State of Idaho when we look at our land
masses.
But now we are off, obviously, on an area that remains
extremely important to both of us and that is energy
production, done appropriately, in the outer reaches of our
country and the difficulties involved and the complications
that we know are there, both in contract and in the
environmental realities.
Again, thank you and congratulations, and I look forward to
working with you.
Senator Feinstein. Thank you very much. I do as well.
Senator Domenici.
STATEMENT OF SENATOR PETE V. DOMENICI
Senator Domenici. Thank you very much, Madam Chairman. I am
delighted to serve on your committee. I have been active
heretofore and hope to continue.
We have a hearing now in the Energy Committee with three
eminent scholars talking about climate change. So there are
three hearings in the Congress today. I figure when those
hearings are finished we will have solved the problem. Maybe
tonight or tomorrow morning we will have it all solved.
Senator Craig. The ice storm will be over and it will be
warm again.
Senator Domenici. In the meantime, let me just make sure
that I state for the record what I know about this situation.
Frankly, the Clinton administration and bidders set about to
procure some leases in 1998 and 1999 and they were signed
without any royalties. Neither side, neither the administration
or the bidders, claim that anything was amiss. They just did
not think royalties had to be in the leases or forgot or made a
mistake, but just did not put them in.
Now, some run around saying that we are being cheated out
of all this money. The truth of the matter is that it is a very
legal situation. It was done in a legal manner. But it is
probably a mistake.
I think, Madam Chairperson, we have to try to resolve this
issue in a way that will bring these oil companies to the table
and talk good sense and suggest that indeed they ought to pay
it as if it was in their leases and then actually change the
leases to reflect that.
I want to ask you, have you asked the Solicitor whether
there is any doctrine, any legal doctrine, which would permit
the two parties to make a change here? Is there a mistake
doctrine that would permit two contracting parties who made a
mistake to come back and amicably adjust the mistake, sir?
Mr. Allred. Senator Domenici, we have looked at that issue
a number of times and, while we always maintain our options
based upon a set of facts that are before us, I think the
report of the Inspector General makes it very difficult to
claim the mistake. What the Inspector General has laid out is
that in the preparation of the 1998 leases, and consequently
the 1999 leases, there was a definitive decision and the person
who wrote them was instructed to remove the price thresholds
from those leases.
What is not clear is why or who gave that instruction. But
given that information from the Inspector General, I believe
that, and I am so advised by our Solicitor, that it would
probably be very difficult to win an argument of mistake.
Senator Domenici. Well, I want to suggest, Madam
Chairperson, that we use this committee and your leadership to
get the oil companies in and have a talk, serious talk about
getting this resolved. There are people here who want to do all
kinds of things as a result of this where they lay blame and
say therefore we want to take away the future of these oil
companies. They do not deserve to be denied any future
drilling. They did nothing wrong.
But we look at it and say, why should you get away with
none for that year when you really should be paying. It is not
like we could enforce it. We cannot go to court and get the
money. I hope everybody understands that. If they could they
would go there.
So I think these oil companies ought to know that to stay
on the good side of Congress as we proceed with further royalty
situations--and we will have a lot of them; we did that one big
bill which you are aware of, that is going to open up a lot of
bidding. These people are going to have to be out there bidding
because they want to make money. We ought to see if we cannot
get them in and say, the best thing for you would be to pay up.
I thank you for letting me mouth off here. I was not able
to do it, but I was not in the right position, and I would help
you in anything you would like to do.
Senator Feinstein. Thank you very much, and I am very
heartened by your comments and we will all work together toward
that end.
Senator Craig, would you like a first round and then we
will go to a second round.
MODIFYING COMPANY CONTRACTS
Senator Craig. Let me pick up where Senator Domenici left
off, because this is obviously an important issue. It is a big
dollar issue. It is also a very complicated legal issue that I
know you are trying to sort yourself through, Mr. Assistant
Secretary Allred. Can you discuss the potential impact to the
marketplace if statutory language was passed that coerced
companies into modifying their contracts? Have you thought
about that?
Mr. Allred. Senator Craig, it is always a pleasure to be in
a hearing with you.
I have thought about that and, as you are aware, much of my
career was in private business, where as a senior executive
officer I had to make decisions about investments. So that
colors my thoughts a little bit about how we deal with this
issue.
Companies are willing to invest a certain amount of money.
In deciding how to invest that amount of money, in order to
reach their fiscal objectives, they are going to look at a
number of things. One of them is risk. That will be either
technological risk or political risk. I think it is interesting
to look at what happens elsewhere where the political risks
become so great that they choose either not to invest or they
choose to only invest in the most lucrative projects.
So, if our concern is to develop as much domestically
controlled oil as we can, I think if we were to develop an
atmosphere here that would raise those risks to a company
seeking to invest, it would be detrimental to our efforts to
develop that oil. So I think again, just as I have concerns
about the unintended consequences of what we do, I think our
decisions have to be well thought out from the standpoint of
business going forward and encouraging people to use private
resources to develop these oil sources that we need.
Senator Craig. Well, we all know that where we are today in
deep water is, while there has been some successes, it still is
on the margin, and there is a margin out there. You call it
risk. It is also an oil company not becoming a partner or a
direct participant anymore with foreign resources, but simply
becoming a service company that ultimately develops them for a
foreign country. I do not think oil companies want that either.
So I have always felt that in correcting this--and I am not
objecting in any way to its being corrected. I tend to agree
with Senator Domenici that this needs to get solved. But it is
important we do it in the context of the broader picture and
what it may or may not do.
For example, would oil companies potentially pay less in
bonus bids for the right to lease offshore if this kind of
uncertainty over the sanctity of contracts is introduced into
the marketplace?
Mr. Allred. Senator, I believe that they would. When you
look at what a company decides to bid on a lease, they will
apportion that among a number of things. For example, one of
them will be bonuses; one of them will be royalty payments and
rental payments; the other one will be the risk I talked about.
If that risk number goes up, obviously the bonus number will go
down.
Senator Craig. Well, there are other questions for me to
ask. I am bouncing back and forth between a couple of
committees. I think it is important, Madam Chairman, that we
solve this problem and work cooperatively with the agency to
get it done in a way that maintains the sanctity of a
government contract, a government relationship with the private
sector. We have phenomenal resources out there. We ourselves
are not in the business of developing them. We are in the
business of developing relationships with the private sector as
they develop them. We have had a good reputation to date in
doing so. As we sort through who did not do what, when, and the
impact it has, I think the issue at hand is getting it over
with, getting it done right, and maintaining a relationship
between the private sector and the government that is a
reputable one.
Senator Feinstein. I agree with you, Senator. Thank you
very much.
INSPECTOR GENERAL REPORT ON LEASE SALES
I would like if I might to begin a second round. Mr.
Allred, I want to just clear up something that you just
testified to by reading directly from the IG report on the
subject: ``We found that shortly after the inception of the
Outer Continental Shelf Deep Water Royalty Act in 1995, MMS
made the policy decision to include price thresholds in the
leases between 1995 and 2000. Field personnel initially
attached addenda to the leases containing price threshold
language, but it stopped for 2 years and instead cited a
regulation that they thought contained threshold language when
in fact it did not. MMS' review process, which included the
Solicitor, simply failed to identify this discrepancy.''
Is that an accurate statement of the facts?
Mr. Allred. Madam Chairman, that is what the Inspector
General believes to be the overall impact. In the detailed
report you will find e-mails and other information from the
person who actually prepared it, where he was told to exclude
it. I have asked this question several times as to who told him
that. The conclusion that the Inspector General came to, was
that it was probably a lack of coordination where rules were
being developed and leases were being written and the two were
never reconciled. That is his conclusion based upon what he saw
out there.
I have no reason to dispute that. There just is no
information as to--and I have asked several times if he could
get more information. He has told me that it is just not
available. So I think that is probably as good a
characterization that could be made.
I think it was a definitive decision to not put them in.
Why that decision or whether anybody realized the impact of not
putting them in I think are two different things.
Senator Feinstein. Well, the report then goes on to say:
``We found that the omission was first brought to the attention
of the former associate director for offshore minerals
management in 2000. She chose not to inform the former MMS
director, preferring to work out a solution within OMM.''
That it seems to me was a big mistake. I mean, to see that
this happened and not bring it to the attention of the director
is certainly a major error in judgment, to say the least.
Mr. Allred. Madam Chairman, in fact there is a letter that
resulted I believe from the incident you are talking about--it
is not in the report, but it is available. The associate
director at that point in time wrote a letter to the oil
companies saying that they should not misinterpret the lack of
price thresholds being in the leases as the authority not to
include them because the Secretary had the prerogative at that
point in time whether or not to include them. So there was a
response to the oil companies. It is a little bit hard from
that letter to understand exactly what they were saying about
the lack of price thresholds in the companies----
Senator Feinstein. May we receive a copy of the letter for
the record, please?
Mr. Allred. Madam Chairman, I believe that your staff
already has that.
Senator Feinstein. We will check. Thank you. Thank you very
much.
[The information follows:]
Mariner Energy, Inc.,
Westlake Park Blvd.,
Houston, Texas, January 12, 2001.
U.S. Department of the Interior,
Minerals Management Service, Gulf of Mexico OCS Region, New Orleans,
LA.
Attn: Mr. Chris C. Oynes, Regional Director
Re: Deep Water Royalty Relief Act Price Triggers
Gentlemen: The Deep Water Royalty Relief Act (``the Act'')
authorized, among other things, royalty suspension volumes for certain
deep water leases in the Gulf of Mexico. When applicable, certain price
triggers eliminate royalty suspension volumes for the year in which the
price of oil or gas exceeds a specified threshold. The Act does not
expressly authorize the Minerals Management Service (MMS) to apply the
price triggers to ``post-Act leases.''
Mariner Energy, Inc., was recently informally notified by your
office that the MMS intends to collect royalty on some post-Act leases
by virtue of a price trigger provision included as an addendum to those
leases. This letter is to outline Mariner's position objecting to
collection of royalty on these leases and to request a meeting where
these issues can be more completely discussed.
background
In 1995, Congress passed the Outer Continental Shelf Deep Water
Royalty Relief Act, codified at 43 U.S.C.A. 1337. Among other things,
the Act authorized royalty relief for certain deep water leases in the
Gulf of Mexico. Specifically, Congress required the automatic
suspension of royalties on all eligible leases purchased in the five
years following the date of enactment, so-called ``post-Act leases.''
The Act also allows qualifying leases in existence on the date of
the Act, so-called ``pre-Act leases,'' to apply for royalty relief. If,
however, oil or gas prices reach a certain ceiling in a given year, the
Act requires the payment of royalties on pre-Act leases. Significantly,
Congress did not include price triggers for post-Act leases. The MMS
implementing regulations, 30 C.F.R. Part 260, also do not contain price
triggers for new leases.
Although not authorized either by statute or agency regulation, the
MMS lease form used for the first four post-Act offshore lease sales
(Sale 157, Sale 161, Sale 166, and Sale 168) contained an addendum with
price triggers. The MMS removed the price trigger language from lease
forms and notices of sale for subsequent sales.
Mariner Energy, Inc., is lessee under several post-Act leases that
contain price trigger language. Three of those leases, Garden Banks 179
and 367, and Ewing Banks 966 had natural gas sales in the year 2000.
discussion
When enacting the Deep Water Royalty Relief Act, Congress expressly
conditioned royalty relief for pre-Act leases on oil and gas prices
remaining below a certain threshold. Congress placed no such
limitation, however, on the automatic minimum royalty suspension
volumes given to post-Act leases.
We contend that Congress intentionally chose not to apply price
triggers to post-Act leases. Post-Act leases were offered for sale with
the promise of minimum royalty suspension volumes to increase leasing
activity in the Gulf and, as a result, bonus bids at post-Act sales
increased significantly. On the other hand, because pre-Act lessees had
already purchased their leases without royalty relief incentives, it
was reasonable to impose a suspension of relief thereafter granted by
the Act when oil and gas prices are high.
Further, while the Act specifically instructs the Secretary to
promulgate implementing regulations, he chose not to include price
triggers in the regulations applicable to post-Act leases. The only
price triggers are found in 30 C.F.R. Sec. 203.78 which applies to pre-
Act leases. By comparison, MMS's recent proposal to extend royalty
relief for future leases by administrative means contains express price
trigger language.
Finally, the fact that MMS removed the price trigger language from
the lease forms and notices of sale after the fourth post-Act sale
indicates the agency's recognition that it was not authorized to
include the price triggers in post-Act leases.
In summary, it is Mariner's position that price trigger provisions
included in post-Act leases are without statutory or regulatory
authority and are therefore unenforceable.
Mariner Energy wishes to thank you in advance for your
consideration in this matter, and we will be pleased to meet, at your
convenience, to more fully discuss the issues.
Regards,
Mariner Energy, Inc.,
Tom E. Young, Vice President-Land.
______
U.S. Department of the Interior,
Minerals Management Service,
Washington, DC, February 14, 2001.
Mr. Tom E. Young,
Vice President-Land, Mariner Energy, Inc., Houston, Texas.
Dear Mr. Young: This letter responds to your letter of January 12,
2001, to the Regional Director, Gulf of Mexico Region, on the subject
of ``Deepwater Royalty Relief Act Price Triggers.'' Therein, you
objected to our intent to collect royalties on certain deepwater leases
and requested to meet with us. We will comment on your specific points
below. After reading our response, if you should still want to have a
meeting, we will be happy to do so. Simply call my office, or that of
the Regional Director so we can arrange a site and time.
As you know, the Deep Water Royalty Relief Act (DWRRA) of 1995
provided for suspension of royalties for specified volumes of
production for both active deepwater leases issued before passage of
the Act and for new leases. As accurately noted in your letter, the Act
also specified certain price thresholds that can rescind the royalty
suspension volumes for years in which oil or gas prices exceed the
thresholds. This past year is the first time the price threshold
provisions have been triggered. The average price for natural gas in
2000 is 13.5 percent higher than the threshold. As gas prices were
rising dramatically throughout the year, we published on our web site
the implications of rising prices on royalty suspension leases. We also
spoke to representatives of your company on numerous occasions about
this emerging energy situation and its potential effect on suspended
royalties. This was to ensure that the effect of higher prices would
not be a surprise to your company.
As you know, the Minerals Management Service alerts bidders in our
proposed OCS lease sale notices about the terms of the deepwater leases
offered for sale on which they bid. The Secretary under U.S.C. 1337 and
30 CFR 260 may set and vary the terms and conditions thereof for each
OCS lease sale. For your leases in question, the price threshold
requirement was noted in the proposed and final Notices of Sale, and
more importantly, in the lease documents that you and any joint owner
signed. Accordingly, we expect that bidders are aware of the price
threshold condition on the royalty incentive before acquiring a
deepwater lease and factor the chance of the royalty suspension being
unavailable under higher prices when formulating their bonus bid
amounts for deepwater leases. Thus, while lease terms may change upon
mutual agreement in certain situations, we think that a change now
would, among other things, provide a windfall to those who bid on the
value of the tracts in the presence of a price threshold. Hence, we
cannot re-consider this lease term as a result of the contractual
condition now being triggered by rising gas prices.
Despite the price threshold terms in your leases, you now contend
that MMS did not have the authority to impose this condition because
Congress explicitly specified price threshold language under DWRRA only
for pre-Act leases. However, when offering leases with royalty
suspensions, the Secretary under the OCS Lands Act (OCSLA), acting
through MMS, does have authority to propose various terms and
conditions on OCS leases, and hence to apply price threshold conditions
for this royalty relief to post-Act deepwater leases as well, as
discussed below.
Section 302 of the DWRRA provides a rather elaborate framework for
evaluating requests for royalty relief from lessees holding certain
deepwater tracts acquired prior to passage of the Act. Within this
framework is a provision in Sections 302(v-vii) for a specific type of
price threshold to apply. It stipulated, inter alia, that in any
calendar year in which actual oil or gas prices exceeded its associated
threshold price (as adjusted for inflation), royalties would be due on
the relevant production for that calendar year even if such production
were subject to an otherwise-approved suspension in royalties.
Moreover, the relevant production in that year would be counted against
any remaining royalty suspension volumes.
In contrast, no such elaborate framework was provided in Section
304 of the DWRRA addressing suspension volumes for newly offered
deepwater leases. Rather, Section 304 referred back to Section 302 and
simply set suspension volumes for leases issued in the 1996-2000 period
at levels equivalent to those specified for pre-Act leases. For
designing the bidding system and specific terms of sale for these
deepwater leases, Section 304 requires MMS to use section 8(a)(1)(H) of
the OCSLA, as amended by Section 303 of the DWRRA. The amendment in
Section 303 not only provides us the general authority to utilize
royalty volume suspensions in future OCS sales, but also states that
the ``suspensions may vary based on the price of production from the
lease.''
Thus, the DWRRA actually provided MMS with even broader authority
to specify or tie the amount of royalty suspension volume to price
conditions for new leases. In practice, MMS chose to use the same price
threshold for new leases as Congress mandated for active ones. This was
partly to ensure administrative efficiencies when leases are unitized.
Congress did not mean to omit specific price trigger language for new
leases because it didn't want MMS to use them. Instead, Congress
provided broader authority for MMS to use or not use price triggers in
a form we determined would be appropriate and consistent with the
objectives of the Act. This observation is also true for other terms
and conditions of sales held during the 1996-2000 period.
You have also stated that certain actions by MMS in promulgating
the implementing regulations and lease notices indicate that MMS
recognizes that it lacks authority to include price triggers for post-
Act leases, but this is not the case. For interim regulations
immediately following passage of the Act, MMS addressed price
thresholds for active leases because Congress had mandated the specific
elements. In contrast, because Congress did not mandate the specific
elements for terms of new leases, we did not address it in regulation.
Rather, we determined that the specific form of certain elements such
as price triggers, would be best determined at the time of sale to
allow more flexibility on the application and form.
For Notices of Sales held in 1998 and 1999, the price trigger
language was left out of the notices and lease documents. This was
within the discretion of MMS and the Secretary. Moreover, the threshold
was reintroduced in subsequent sales. Therefore, it is incorrect for
you to conclude that the omission of price threshold language from an
earlier version of MMS's regulations or certain lease sale documents is
germane to the question of MMS's authority in include price triggers
with royalty suspension for post-Act leases.
We can understand that lessees are not anxious to have royalties
due when price thresholds are actually exceeded. However, the intent of
DWRRA, and MMS policies implementing it, were understood similarly by
all stakeholders from the outset--i.e., to provide sufficient financial
incentives to promote deepwater activity under certain conditions, with
oil and gas prices being an explicit consideration. We believe Congress
included references to product prices and specific price thresholds in
the Act to protect interests of the Treasury for those years when
prices rise to levels where the royalty incentive in no longer needed
or appropriate, and in instances where MMS's authority to set terms and
conditions unilaterally, i.e., for active leases, is less flexible than
for new leases.
In general, when oil or gas prices rise significantly relative to
historic trends or price expectations, the profit gains to the lessee
far outweigh any royalties due the government as a result of the price
threshold terms. It is reasonable that the nation, as owner of the
mineral resources, should participate in the revenue benefits of the
price gain, as it was willing to provide the financial incentive when
needed to promote the development of the resource at lower prices.
We appreciate your interest in our program and your willingness to
share your concerns with us. But, we see no reason at this time to
change our position concerning the application of price threshold terms
in post-Act deepwater leases.
Sincerely,
Carolita U. Kallaur,
Associate Director for Offshore Minerals Management.
Senator Feinstein. So then is there any information that
the Secretary would have known that these were not included?
Mr. Allred. Madam Chairman, as I understand from the
Inspector General, there are no records and he has been unable
to determine whether anybody above that level at that point in
time understood that they were not in there.
Senator Feinstein. Thank you.
COMPLIANCE AND AUDITING
Let me proceed with my questions then. Now, the Inspector
General reported that compliance reviews are an important part
of the compliance and asset management program, but are no
substitute for full audits. How do those reviews differ from
royalty audits?
Mr. Allred. Madam Chairman, first a little bit about what
is due the U.S. Government in order perhaps to explain what
occurs. Oil or gas is produced. It is metered through a meter
that the Mineral Management Service supervises. So we know
through both the meters and then subsequent production reports
from the companies how much is being produced out of a well.
Then that oil or gas has to be transported to a place of
collection or a place of use and it generally has to be
processed to remove water or to separate oil and gas or
whatever the process might be. When we look at Federal revenues
and Federal royalties, it is the amount of oil or gas produced
at the well, which we know, with certain costs subtracted, and
those costs that are subtracted are the allowable costs for
that transportation and the allowable costs for that
production.
That is where the problems develop. It is just like
deductions on income tax. You get arguments about what is a
proper deduction and what is not. That is where the questions
arise when we talk about these audits. It is not generally
about how much was produced. It is a question of how much was
deducted from the value of that which was produced.
We do two processes. The first is a full audit, where we go
in and look at the costs of those companies, which either
sometimes they are owned by the producing company, sometimes
they are vendors, but to look at those total costs and to
determine whether those deductions are proper or not under our
rules.
There are a lot of situations. For example, as I indicated,
some of those pipelines may be owned by, in part by the
producer, or they may be owned by someone else. We have to
determine which case that is and to what extent it is.
When we do a compliance audit, rather than a full audit,
what we do is we compare----
Senator Feinstein. Is that different from a compliance
review?
Mr. Allred. That is different from a compliance review. The
full audits----
Senator Feinstein. Yes, what are the criteria for an audit?
Mr. Allred. It would be--a good many times they are
triggered either by a compliance review or a periodic audit of
that particular----
Senator Feinstein. But my understanding is there is no
criteria for an audit in the MMS.
Mr. Allred. Madam Chairman, no, we have criteria. If we
have any reason to believe, either through records or other
sources of information, that we are not being paid the full
amount, we can audit. Keep in mind that there are two other
audit functions here in addition to the Federal Government.
There are the States and there are the Indian tribes which also
receive these revenues, and they are part of the audit program,
too.
But we have a number of criteria, which obviously we keep
rather quiet as to what triggers an audit. But those audits are
also very expensive and require lots of manpower. As the work
load is increased--and it has increased significantly as we
have new production--we have also added a second tier, and
those are the compliance reviews. Those compliance reviews
include information that we have. Keep in mind that we know
what is being produced from the meters we supervise and from
the reports that are supplied by the producer and also by
reports that are supplied by the buyer. We then look, based
upon our own information as to what transportation costs are or
what processing costs are, do a review of what we are being
paid. That will trigger questions in our minds. Sometimes it is
obvious we have been underpaid and we bill the companies. They
can challenge it, but we bill the companies.
In those cases where we have big questions about whether
they have paid, it will trigger a full audit. Now, what the
Inspector General recommended that we do is that we better
develop the risk criteria by which we do those compliance
reviews, and we are in the process of doing that. We have them,
but he felt they needed to be more formalized.
I would also indicate that, again going back to my
experience as a corporate executive, if you look at the facts
which are in the audit of our royalty management, I was not
necessarily surprised by what is in there. Those are the kinds
of things you normally would see in a review of operations.
Anything, as I indicated in my testimony, anything that is as
large and as complex as royalty management is, there an outside
audit will find lots of opportunities to improve it. That is
why we periodically do these. It is important to have that
outside review, and MMS has accepted most of those
recommendations, those that it is capable of accepting, and we
will implement those improvements.
CLOSING REMARKS
Senator Feinstein. Thank you very much, Mr. Allred.
I think you heard the questions from members of the
committee and, as you probably know, we discussed this issue
last year at an Appropriations Subcommittee--excuse me, at the
full Appropriations Committee, and I moved some language which
was included in the appropriations bill, which of course is now
the product of the CR.
But I want you to know that it is my intention to work with
Senators Domenici, Craig, and members on this side as well as
the other side, to include specific legislation in this bill
which will in fact recover the money due to the taxpayers. I
feel it very, very strongly. These companies have reaped record
profits. I think one of them has reaped quarterly the greatest
profits ever reaped by any American corporation. I believe they
deserve to repay the taxpayers for the loss of this money.
So we look forward to working with you on the how-to part
of it and I think there are a couple of good ideas that you
have mentioned and we will explore those more fully.
CONCLUSION OF HEARING
Do you have any further comments you might like to make at
this time? If not, I will recess the hearing.
Mr. Allred. Madam Chairman, we look forward to working with
you and to help solve this problem.
Senator Feinstein. Thank you very much.
[Whereupon, at 10:54 a.m., Tuesday, February 13, the
hearing was concluded, and the subcommittee was recessed, to
reconvene subject to the call of the Chair].
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