COLLECTION OF ROYALTY UNDERPAYMENTS
ON CALIFORNIA CRUDE OIL

In June 1994, the Department of the Interior commissioned an interagency team to address possible underpayment of royalties on Federal crude oil production in and offshore California. In May 1996, the team concluded in its final report that companies often received gross proceeds higher than posted prices and that since most Federal royalty payments were based on postings, royalties have been underpaid. Based on this report and the associated analysis, the Minerals Management Service (MMS) is initiating collection activities.

Consistent with the information the interagency team developed, the MMS will pursue unpaid royalty from the top 20 producers for the period January 1, 1980, to present. (This will cover nearly 97 percent of the Federal production in California during the period.) MMS valuation procedures distinguish between arm's-length transactions, typical of non-integrated companies, and non-arm's-length transactions, typical of integrated companies. Further, MMS regulations were amended on March 1, 1988, to codify these differences. Therefore, the MMS compliance plan takes account of these different types of transactions. MMS estimates the total underpayments, including interest, to be approximately $440 million. ₁

Integrated Companies

For periods prior to March 1, 1988, the price for Alaska North Slope (ANS) crude oil ₂ , adjusted for quality and transportation, will be used to establish value for royalty purposes of other than arm's-length sales. For true arm's-length sales, value will be based on gross proceeds, including any premiums. MMS will apply this approach immediately for the period October 1, 1983, through February 29, 1988, (because it has more complete automated records for that period) and issue orders to pay. As soon as records for the January 1, 1980 - September 30, 1983, period are located and reviewed manually, additional orders will be issued.

For periods beginning March 1, 1988, when MMS revised its crude oil regulations, audits of sample transactions will be conducted. For other than true arm's-length sales, royalty valuation will be based on the higher of gross proceeds or the valuation benchmarks in the MMS regulations, which are based primarily on arm's-length transactions in the field or area, including any premiums paid. True arm's-length sales will be valued based on gross proceeds, including any premiums. All orders will exclude crude oil taken in-kind by MMS and sold to small refiners.

Non-Integrated Companies

Since non-integrated companies are presumed to have sold oil at arm's-length, it is appropriate to use gross proceeds from their arm's-length transactions to determine value. For these companies, audits will be conducted on a sample transaction basis for representative time periods from January 1, 1980, to current periods. These audits will determine if the companies systematically paid royalties on less than arm's-length gross proceeds. When underpayments are identified, orders to perform (i.e., to recalculate royalties correctly consistent with gross proceeds) will be issued. These orders will exclude crude oil volumes subject to price controls or for which royalties were taken in-kind by the Federal Government and sold to small refiners.

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The MMS will initiate these actions beginning immediately. The MMS will work closely with the State of California Controller's office, with which it has a delegated audit agreement. This effort will also utilize all information collected by the interagency team, available from the State of California's litigation files, or the outside consultants retained to provide marketing and other pertinent California crude oil valuation information. The MMS expects to issue its first orders and bills within the next few months and conclude its audits and billing efforts within a year after all necessary data is received. In some cases records may be difficult to obtain. If companies deny access to needed information, subpoenas will be issued.

Crude Oil Valuation Nationwide

We are also actively pursuing similar oil valuation issues occurring in other States and on the Outer Continental Shelf. Specifically, in June 1996, MMS issued valuation guidance to its auditors explicitly stating that premiums received by a lessee represent gross proceeds and are therefore royalty bearing. Audit personnel have also been instructed to hold open the most recent audit period and to consider these oil valuation issues in all audits. Finally, MMS plans to propose new oil valuation regulations by the end of this year.

1 The Interagency Team's report estimated that potential underpayments, including interest, for Federal crude oil porduced in and offshore California might be as much as $856 million for the period 1978-1993 based on ANS prices. However, this implementation plan does not envision collection of additional revenues for the years 1978 and 1979, on royalty in-kind volumes, on crude oil attributable to periods closed by settlement agreements, or using ANS as the valuation method for March, 1988, forward.

₂ During the periods in question, ANS crude was a substantial portion (up to 50 percent) of California refiners' crude oil feed stock and was freeley traded in arm's-length transactions. This makes ANs crude a relevant and reasonable measure of crude oil value in the California market.

updated July 18, 1996