GAO Calls Interior's Estimate of Lost Royalties Too High

Federal royalties in jeopardy because of industry litigation are substantial but may be well below the $60 billion figure estimated by the Interior Department, according to a new Government Accountability Office report.

The same report said Interior should update Congress regularly about billions of dollars that may be lost if the lawsuit succeeds and about potential losses from separate problems with late 1990s Gulf of Mexico leases that allow royalty waivers regardless of energy prices.

"The Congress needs accurate and timely information to consider legislative action to recoup forgone royalties," states the report to Senate Energy Committee Chairman Jeff Bingaman (D-N.M.) and other Senate and House lawmakers.

The findings and recommendations are part of an April 12 report on controversies surrounding the federal "royalty relief" program. The program -- launched in the mid-1990s -- provides incentives for costly deep water Gulf of Mexico projects by waiving production royalties.

Interior's Minerals Management Service mistakenly failed to include clauses in 1998 and 1999 leases that suspend the subsidies when prices surpass certain limits. The absence of so-called price thresholds has already cost an estimated $1 billion in lost royalties and could eventually cost the Treasury an estimated $10 billion.

In addition, The Kerr-McGee Corp. sued MMS last year challenging price thresholds in 1996, 1997 and 2000 deep water leases (Greenwire, March 2). The company claims Interior lacks authority under the Deep Water Royalty Relief Act to apply price thresholds to royalty relief leases during the 1996-2000 period. The lawsuit, if successful, could mean up to $60 billion in forgone royalties industry-wide, according to an earlier MMS estimate.

But GAO's report says that number, the result of a 2004 MMS estimate, may be too high. The report notes that of the 2,369 leases issued in 1996, 1997 and 2000, 1,294 have expired with no oil or gas production.

GAO says that among the remaining leases, 12 have produced and "have either reached the end of their productive lives or appear incapable of further production." Thirty-eight were still producing as of July 2006, while 26 appear capable of producing in the future if they're connected to infrastructure, GAO said. Otherwise, 999 are active but have not been tested to see if they can produce.

"In our review of the methodology and assumptions used in MMS' 2004 estimate, we found that MMS may have made overly optimistic assumptions about the amount of oil and natural gas production that would occur over the lifetime of these leases," GAO states.

At the same time, GAO noted increases in oil and gas prices since the 2004 estimate of potential forgone royalties.

MMS officials agreed with the assessment and "also agreed that a new estimate of potential forgone royalties might be considerably lower than their earlier $60 billion figure," the report added. MMS officials told GAO they are not working on an updated figure, the report states.

On the 1998-1999 lease issue, GAO says MMS's estimates of losses from future production in the $6.4 billion to $9.8 billion range seem reasonable. GAO modeled the potential losses using various price and production scenarios and came up with a low estimate of $4.3 billion in lost future royalties and a high estimate of $10.5 billion.

Congress seeking royalty fixes

For their part, lawmakers are looking for ways to fix problems with the 1998-1999 leases. The House passed legislation in January that would deny new gulf leases to companies that do not agree to the price thresholds or pay other new "conservation of resources" fees. And Bingaman plans to introduce legislation soon to ensure the royalty payments, even as he warns that the House plan is vulnerable to legal challenge.

"My fundamental goal in moving ahead on this serious matter is to recover the lost funds," Bingaman said in a prepared statement yesterday. "I plan to carefully review the report and will soon introduce legislation that builds on GAO's recommendations."

Sens. Dianne Feinstein (D-Calif.) and Pete Domenici (R-N.M.) support providing three-year extensions to the 1998-1999 leases if energy producers renegotiate the contracts to include the price thresholds. Interior supports extending leases as an incentive to renegotiate and has urged Congress to pursue this path. Interior opposes the House-passed plan, saying it could lead to litigation that would delay leasing.

Interior has already reached agreements with a half-dozen gulf producers -- including Shell, BP and ConocoPhillips -- on applying price thresholds to future production from the 1998 and 1999 leases. But roughly 40 companies that hold leases from those years have yet to reach agreements with the government.

Interior officials have said that new agreements are unlikely until companies know how Congress will act on the issue. Also, GAO concludes that uncertainty about the legal challenge to Interior's authority to set price thresholds on any leases may "further deter or complicate" settlements.

GAO calls for continued MMS updates to Hill

GAO says MMS needs to provide Congress with continuous updates on the potentially lost royalties.

"As Congress considers ways to address forgone royalties, it will need the best available information on a year-to-year basis about royalties that have been forgone to date, those that have been paid but that are at risk in the suit, and estimates of how much is at stake going forward," the GAO report says.

GAO calls for MMS reports to Congress on the status of the 1998-1999 leases and the annual amount of forgone royalties until the issue is resolved. It also calls for MMS updates to Congress on the status of leases from 1996, 1997 and 2000 and the annual royalties collected from them to date until the Kerr-McGee lawsuit is resolved.

In addition, GAO calls on MMS to provide "periodic updates, as MMS resources allow" of future forgone royalties from the 1998 and 1999 leases, and future royalties that may be at risk from the 1996, 1997 and 2000 leases until both issues are resolved.

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Company: Minerals Management Service (MMS) more info
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