Congressional Testimony

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Mr. Chairman and Members of the Committee, I appreciate the opportunity to appear before you today to provide you with our initial analysis of S. 924, the Federal Royalty Certainty Act. Having received a copy of the Bill on April 30 our analysis is preliminary, however my testimony does include some general discussion. I would also like to take this opportunity to update you on our recent efforts to revise our Federal crude oil valuation regulation and on our reengineering efforts.

As we understand it, the Bill is intended to eliminate or greatly reduce administrative costs of the current royalty program by providing simple, clear, and certain guidelines, and proper adjustments to value when sales are made downstream of the lease. MMS is also interested in obtaining certainty, simplicity, minimizing royalty disputes, and assuring a fair return for the public’s natural resources.

The Bill reverses longstanding principles of royalty collection which would significantly compromise federal royalty valuation and amounts shared with the states. Given our review, the Secretary would recommend to the President that he veto this Bill. We believe that a better course of action is our current approach of directly involving all parties to this debate in a detailed dialogue over royalty valuation. We have gained a significant amount of momentum in addressing the concerns of both the oil and gas industry and the public recipients of royalty revenue through such dialogue.

Preliminary Analysis of S. 924

Senate Bill S.924 would amend Section 8(b)(3) of the Outer Continental Shelf Lands Act and Section 17(c) of the Mineral Leasing Act by adding specific provisions governing the value, for royalty purposes, of Federal oil and gas.

The Bill contains ambiguous or undefined terms, such as "other disposition," "other services," and "beyond the lease," which may lead to increased litigation between the lessees and the Federal Government.

The adjustments proposed to be deducted from value when production is sold away from the lease fundamentally change longstanding valuation principles (upheld by various Courts) by forcing the Government to share in costs that have historically been the responsibility of the lessee. The effect of the changes in this Bill will draw the Government closer to a silent partner rather than a royalty-owner relationship. Unlike a commercial entity, the Federal Government would be unable to exercise the rights of a working-interest partner in developing operating and other agreements. The Bill would have the Federal Government share in costs over which we have no input.

In summary, our preliminary analysis indicates that, if S. 924 is enacted, it will decrease royalties by as much as $250 million per year. States that share in the royalty revenues from Federal oil and gas leases located in their State would share in these losses. Costs that would be transferred to the Federal Government under S. 924 fall into three areas:

• Marketable condition - While the Bill does not change the requirement of the lessee to place production in marketable condition when it is sold at the lease, it would transfer those costs to the Federal Government when production is treated and sold away from the lease, as commonly occurs.
• Marketing - The Bill provides for reimbursements for marketing. The Government historically has not shared in these marketing costs.
• Transportation - The Bill provides for reimbursements for "transportation to the point where the production is put in marketable condition," a phrase that would include gathering costs that MMS does not currently allow. The Bill also increases the revenue loss by changing how transportation allowances would be determined for non-arm’s-length situations.

Federal Crude Oil Rulemaking Process

Three and one-half years ago, the Department embarked upon a modification of its Federal crude oil valuation regulations. This was necessary because changes in the crude oil market had evolved to the point where royalty payments to the Federal Government, based on the regulations in effect, no longer were calculated on the market value of the production. These regulations, which were drafted in the mid-1980's and published in 1988, are still in effect today and are used by the industry to calculate royalty payments on Federal production.

Throughout the process we have been guided by several basic principles-- (1) provide certainty to all involved; (2) simplify royalty valuation; (3) reduce the need for audit; (4) minimize royalty disputes; (5) provide maximum flexibility to adapt to changing market conditions; and (6) assure that the taxpayers of this nation get a fair return for their oil and gas resources.

Since we issued an advance notice of proposed rulemaking in December 1995, MMS has published 4 proposed rules, opened 6 public comment periods, had 17 public workshops and meetings, reviewed thousands of pages of comments, and held numerous meetings with Members of Congress and their staff. MMS received comments from States indicating that postings no longer reflected market value and that some form of index pricing would be appropriate. Industry opposed many aspects of the proposed rule but no longer supported reliance directly on posted prices as a basis for valuing non-arm’s-length transactions.

In the Spring of 1998, a moratorium was added to a FY 1998 Emergency Supplemental Appropriations Act (PL. 105-174) that barred MMS from implementing crude oil rulemaking until the end of FY 1998.

On August 31, 1998, Assistant Secretary Armstrong sent an outline of the direction we were heading in the final rule to several Members of the Senate Energy Committee. This outline reflected many changes we were considering as a result of the consultation process.

The moratorium was then extended by the FY 1999 Omnibus Appropriations Act ( PL. 105-277) until June 1, 1999, or until a negotiated agreement is reached. The Senate Appropriations Committee added a rider provision to the FY 1999 Emergency Supplemental Bill which would further delay implementation of the proposed rule from June 1, 1999 to October 1, 1999.

In March, 1999, the Secretary announced plans to reopen the comment period for the rule. This decision was in response to many requests from Members of Congress and parties interested in moving the process forward to publish a final rule. On March 12, MMS reopened the comment period for 30 days until April 12. MMS held three additional workshops to discuss resolution of outstanding issues on the rule. Prior to holding the workshops, MMS worked with industry representatives to develop a meeting process to ensure that the workshops would be productive. Workshop discussions focused on five areas where industry needed additional clarification from MMS, and/or had new proposals: (1) How should value be determined under non-arm’s length transactions; (2) can MMS issue binding determinations; (3) what other adjustments to downstream value should be considered; (4) will MMS accept arms-length gross proceeds as value; and (5) how can the lessee rebut the presumption of control under the definition of affiliate? MMS held constructive dialogue at the workshops with all parties. Suggestions were made by industry, as well as States and public interests groups. This allowed all parties to better understand each other’s positions on our rulemaking efforts. We had the opportunity to ask questions and discuss some concerns that we had with certain portions of the proposals offered.

All notes from these meetings and related documents are available on the RMP webpage under the Federal oil site (www.rmp.mms.gov/library/readroom/FedCrudeOil/FCMarch99.htm). The comment period was further extended until April 27, to allow time for additional comments as a result of the workshops. Now that the comment period has closed, we are reviewing all written comments in addition to the comments and proposals received at the workshops. After completing our review, we will decide on the next course of action in the rulemaking process.

MMS is currently shifting to a market-focused business environment by reengineering the Royalty Management Program (RMP). Although the effort will take several years to fully implement, it is necessary because of new legislative mandates, changing energy markets, the need for more cost-effective operations, and outdated computer systems. In November 1998, RMP issued "Road Map to the 21st Century," that charts key action elements of the RMP implementation path over the next 3 years and lays out time lines for specific accomplishments. This effort is expected to be fully implemented and operational by the year 2003.

Two goals have been established: (1) to ensure that royalty recipients will have access to their revenues within 24 hours of the time MMS receives it, and (2) to ensure royalty compliance within three years as opposed to six years.

The reengineered program will be organized around two core business processes: the financial management process, which will focus on financial accounting and the receipt and distribution of revenues, and the compliance and asset management process, which will focus on the entire realm of activities related to producing properties.

In devising the framework for the effort, MMS is working closely with States, Tribes and the oil and gas and coal industries since they are the ones who will be primarily affected by and the beneficiaries of the new system. In fact, we have reached agreements with several companies to become full working partners in our operational models now underway. BHP New Mexico Coal, Cyprus Amax Minerals Company, Kennecott Energy Company, Pacificorp, Peabody Group, and Westmoreland Resources, Inc. will partner with us and the States of Colorado, Montana, Utah, and Wyoming and the Navajo Nation and Crow Tribes in our Solid Minerals Operational Model. Amoco, Chevron USA, Texaco, Coastal, Barrett Resources, and Devon will partner with us in our Oil and Gas Operational Models. The States of Colorado and Utah and the Ute Tribe will join us in our Onshore Oil and Gas Operational Model.

We believe this initiative is an excellent investment because it will:

• Improve the timeliness and accuracy of payments to the States and Tribes;
• Save the minerals industry millions in operating and administrative costs by

- streamlining reporting requirements by 40%,

- shortening the compliance cycle from 6 to 3 years,

- aligning processes more closely with industry’s, and

- improving information access and sharing capabilities;

• Reduce MMS’ administrative costs by $3.5 million per year;
• Increase compliance with laws, lease terms, and regulations.

Conclusion

In closing, Mr. Chairman, we do not believe that S. 924 is the answer to the continuing debate over royalty management, as it would not provide either certainty or decreased costs to Federal royalty management. This Bill would also reduce royalty collections by redefining the duties of lessees. As stated above, we believe that a better course of action is our current approach of directly involving all parties to this debate in a detailed dialogue over royalty valuation. We have gained a significant amount of momentum in addressing concerns of both the oil and gas industry and the public recipients of royalty revenue through such dialogue. Now is not the time to give up on this admittedly large task. Rather, it is the time for all of us to redouble our efforts to fashion a solution that achieves the best balance among various competing objectives while meeting our goals of certainty, simplicity, minimizing disputes, and ensuring a fair return for the public.

Finally, although we note the recent upturn in both the natural gas and crude oil markets, we share the Chairman's concern for the health of the domestic oil and gas industry, an industry that makes such important contributions to our economy and energy independence. Our continuing concern in this area is underscored by the many Department of the Interior initiatives designed to assist the industry in recent difficult times. I would like to clarify, however, that the oil rule has nothing to do with the recent low prices that have plagued the industry. We do not believe that compromising the oil valuation rule is the proper way to address the industry’s problems. The purpose of these regulations is to fulfill our responsibility to capture market value for the public’s resources. When the market goes up, our royalties go up. When the market goes down, we suffer in tandem with the industry. We believe that other avenues, such as reduced reporting burdens and royalty rate reductions -- not permanent changes to valuation policies -- are a better way to help the industry in times of economic distress.

This concludes my written testimony. However, I will be pleased to answer any questions you or Members may have regarding MMS’s proposed Federal oil valuation rule or any other issues that I raised during my testimony.

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updated August 6, 1996