American Geological Institute

Government Affairs Program


Update and Hearing Summary on Royalty Payments for Oil and Gas (11-6-98)

Final Action in the 105th Congress:
The FY99 Interior Appropriations bill contains language to delay the MMS oil valuation rule for eight months. Debate on the rule and royalty in kind will likely begin again early in the 106th Congress.


In the nearly two years since President Clinton signed the Federal Oil and Gas Royalty Simplification and Fairness Act into law, the Minerals Management Service (MMS) and the oil industry have been engaged in a debate over how to develop regulations from the law. The debate also involves Congress and the States in an effort to determine what constitutes fair valuation of oil and gas royalties, as well as how to simplify the collection of royalties from federal lands. Central to the debate is the choice of a collection system -- whether to take royalties in-kind, instead of in-value. Many in the oil industry support a royalty-in-kind system. Although MMS regulations allow the agency to receive royalties in-kind, the agency is reluctant to take all royalties that way, especially in remote regions and from low-yield marginal wells.

Both MMS and members of Congress have introduced new royalty valuation methods. In February 1998, the Department of the Interior proposed new regulations which would base the price of federal oil royalties on the New York Mercantile Exchange market price and the Alaskan North Slope spot price. That rule was later changed to allow basing the royalty payments on the price determined between an oil producer and a willing buyer. Earlier this year, Rep. Mac Thornberry (R-TX) introduced the Royalty Enhancement Act of 1998, H.R. 3334, that would require MMS to receive all oil and gas royalties in-kind. Since its introduction, the bill has been the subject of several hearings, predominantly in the House Resource Subcommittee on Energy and Mineral Resources of which Rep. Thornberry is a member. The subcommittee passed the bill on June 18th. The Senate has also held a hearing on this topic. This update contains information on:


Most Recent Action

At the request of Rep. Ralph Regula (R-OH), Rep. Carolyn Moloney (D-NY) and Senator Barbara Boxer (D-CA), the General Accounting Office (GAO) prepared a report on federal oil valuation that was released in mid-August. The report supports the proposed MMS rule, noting that oil companies routinely receive more for oil than the price they provide to MMS for royalty calculation and that the federal government does not have the right conditions to take royalty in kind. The report is available on the GAO website.

Over the summer, MMS and representatives from the oil companies met several times to discuss the proposed oil royalty valuation rule the agency hopes to put into effect in October of this year.  On July 9, Senators John Breaux (D-LA) and Kay Bailey Hutchison (R-TX), co-chairs of the Congressional Oil and Gas Forum, invited several senators, MMS administrators, and oil industry representatives to a meeting in hopes of resolving the differences between the parties on fair royalty valuation regulations.  A follow-up meeting to continue the discussion on July 22, allowed participants to address issues of transportation and gathering that were brought up as areas of concern.  On July 21, Representatives Miller (D-CA) and Maloney (D-NY) invited MMS administrators, state officials, and environmental groups to a public roundtable discussion on the proposed regulations.  There was another follow-up meeting between Senate staff members and Department of the Interior administration on July 28, to further discuss proposals made by the oil industry. The negotiations appear to have paid off. In early September, MMS announced that it would revise the rules to clarify procedures for sales that include more than one arm's length sale and gave producers in the Rocky Mountain region the option of using benchmarks instead of the index price if they chose not to trace the production to an arm's length sale. In a letter to Senators Breaux, Hutchison, Domenici, Murkowski and Nickles describing these changes, Assistant Secretary for Land and Minerals Management Bob Armstrong called on the Senators to repeal the provision in FY99 Interior Appropriations bill to stall implementation of the rule until October 1, 1999. According to Environment and Energy Weekly, the new rule does not have the support of industry because it does not move away from using downstream prices as a baseline. More information is available on the MMS website.

Background

Debate is raging between Congress and the Administration on the best way to receive royalties for oil and gas on federal land. Traditionally, the Department of the Interior has based oil and gas royalties on fair market value, typically defined as "the gross proceeds realized by its lessees under arm's-length sales." Changes in the world market have fostered disputes and litigation over this method. In addition, the House Committee on Government Reform and Oversight released a report entitled "Crude Oil Underevaluation: The Ineffective Response of the Minerals Management Service" that showed federal royalties were undervalued and up to $2 billion in royalties has been unpaid. Since the release of that report, the Department of the Interior has proposed new regulations which would base the price of federal oil royalties on the New York Mercantile Exchange market price and the Alaskan North Slope spot price. That rule was later changed to allow basing the royalty payments on the price determined between an oil producer and a willing buyer.

Many in industry are opposed to this rule. Joe Lastelic, a spokesman for the American Petroleum Institute, claims that the rule would be "too vague , too uncertain and complicated." Instead, oil companies have lobbied in favor of taking royalties in-kind (RIK), eliminating the price question entirely. In an RIK program, producers would give the government a physical share of the oil and gas production, which the government would then market and sell. In March, Rep. Mac Thornberry (R-TX) introduced HR 3334, Royalty Enhancement Act of 1998 that would mandate that the "US must take all royalty oil and gas in kind." The bill is supported by the Domestic Petroleum Council and Independent Petroleum Association of America, but not the Administration. In a March 19 hearing before the House Resources Subcommittee on Energy and Mineral Resources, Minerals Management Service (MMS) Director Cynthia Quarterman stated that she "strongly opposes any legislation mandating the US to take its mineral royalties in kind and would recommend that H.R. 3334 be vetoed if presented to the President." Although MMS favors investigating the possibilities for RIK, it still feels "RIK is unproved and risky for royalty collection in the US." Quarterman contended that H.R. 3334 would force the US to relinquish many of its long-established legal rights as lessor while relieving lessees of many of their legal obligations and force the government to take RIK in areas where conditions are unfavorable, causing potential losses of $367 million. She repeated those views in a hearing held May 21. The legislation was in part based on testimony received in RIK hearings held on July 31, 1997 and September 18, 1997 as part of an effort to comply with language in the 1997 Interior Appropriations bill that urged consideration of royalty-in-kind initiatives by MMS.

In early May, MMS announced that its valuation rule would be published in June with an effective date of October 1, setting off a flurry of activity in Congress. Senator Kay Bailey Hutchison (R-TX) succeeded in amending a supplemental spending bill (HR 3579) to include a provision prohibiting the use of federal funds in the current fiscal year for the rule, effectively stalling its implementation to allow for more Congressional review. In signing the supplemental appropriations bill, President Clinton stated, "It is very troubling that the Congress placed politics above sound science .... I am very concerned about the limitations placed on the Government's ability to ensure a fair return for oil and gas resources extracted from Federal lands. My Administration will oppose any efforts to make these limitations permanent."

Several Democrats moved swiftly to introduce legislation to undo the amendment. Rep. George Miller (Calif.) introduced legislation (HR 3820) on May 7 to rescind the Hutchison amendment. A companion bill (S 2043) was introduced by Senator Barbara Boxer (Calif.) the same day. A congressional Democratic source said that even if the legislation might not go anywhere, it would highlight that what Republican conferees did was a "sleazy deal."

Rep. Maloney (D-NY), long opposed to the federal government being shortchanged by oil companies on payment of oil royalties, introduced legislation (HR 3932) to ensure that American taxpayers receive royalties based on market value for production of oil from federal lands. Maloney's proposed legislation, while allowing small independent oil producers to continue paying oil royalties under the traditional gross proceeds method, requires others to base their royalty payments on either the New York Mercantile Exchange market price or the Alaska North Slope spot market price.  The bill was referred to the House Resource subcommittee on Energy and Natural Resources in early June and has seen no action.

Several of the studies on benchmarking, fair valuation, RIK programs, and other concerns are available in PDF format at the MMS library.


Hearings


House Oversight Hearing on the Feasibility to Take Federal Oil and Gas Royalties In-Kind

House Committee on Resources

Energy and Mineral Resources Subcommittee

July 31, 1997

Witness list
Rep. Carolyn Maloney, New York
Jim Magagna, Director, Office of State Lands and Investments, Wyoming
Spencer Reid, Deputy Land Commissioner, Texas General Land Office
David Darouse, Mineral Revenue Regional Auditor Supervisor, Louisiana
Larry Nichols, President, Devon Energy
Fred Hagemeyer, Coordinating Manager, Royalty Affairs, Marathon Oil Company
Sue Ann Hamm, Vice President, Oil Marketing and Sales, Continental Resources
Edmund Sender III, Executive Vice President and Chief of Staff, Enron
Cynthia Quarterman, Director, Minerals Management Service

Members Present
Chairwoman Barbara Cubin (R-WY)
Ranking Member Carlos Romero-Barcelo (D-Virgin Islands)
Mac Thornberry (R-TX)
Kevin Brady (R-TX)
Calvin Dooley (D-CA)
Chris John (D-LA)

Opening statement
Chairwoman Cubin began the hearing by explaining the immense economic effects of mining royalties on her home state of Wyoming and her desire to create a more efficient system of collecting "what is owed to the federal government." Cubin is interesting in examining the merits of a RIK program and working towards a goal of "increased efficiency [which] means greater net revenues to all concerned."

Testimony
Rep. Carolyn Maloney was the first witness, as requested by the committee Democrats. Rep. Maloney opposes RIK for several reasons. First, she believes the 1996 Federal Oil and Gas Royalty Simplification and Fairness Act will allow greater clarity and reduce legal fees and challenges once it is fully implemented, eliminating the need for another overhaul. Secondly, since many companies are both producers and marketers, oil companies would get paid to market the oil they had given in-kind to the government. Finally, she does not believe the federal government has the equipment or incentives to become an effective competitor in the oil and gas industry.

Panel 1: State Government
Mr. Reid spoke favorably about the RIK program in Texas. In the 14 years of its existence, RIK has saved state agencies $90 million in energy costs and has provided money to the public school fund. Texas takes oil and gas at the point it is ready to be sold, but has the right not to buy. Mr. Darouse testified that Louisiana has not had success with RIK programs, primarily due to legislative and geographical constraints. Louisiana is currently working to better enforce leases. Mr. Magagna applauded MMS efforts and the possibility of revenue enhancements. He emphasized the importance of state involvement in the rule making process.

Panel 2: Oil and Gas Industry, Producers, and Marketers
Mr. Nichols testified in support of RIK for the Inter-Association Work Group, a coalition of 13 oil and gas trade associations. He stated that now is the time to "build a successful royalty in-kind program, once and for all bringing an end to years and years of disputes and debate about royalty payment." Mr. Hagemeyer also supports RIK because it would reduce or even eliminate "the administrative burdens of both the MMS and federal lessees, especially audit and litigation costs." Ms. Hamm referred to the success of both her company's and Canada's RIK program. Mr. Segner testified that most of the problems associated with the recent changes in the oil and gas market can be eliminated by "introducing a program in which the federal government takes and markets for its own account its share of oil and gas production from the public lands." According to Segner, a successful RIK program would be simple, predictable, and fair and should utilize private sector marketers. It would benefit both the government, who would receive the full market value for its share, and the producers, who would spend less time and money from an administrative viewpoint.

Panel 3: Federal Government
On behalf of MMS, Cynthia Quarterman testified that she was "not convinced that crude oil RIK is in t he best interest of the United States." She did state, however, that she was encouraged by prospects for gas RIK. These decisions are based on preliminary studies, and MMS is open to additional pilot programs and studies to determine the best way to manage the "revenues generated from the Nation's public resources."


House Oversight hearing on the Feasibility to Take Federal Oil and Gas Royalties In-Kind (Part II)

House Committee on Resources

Subcommittee on Energy and Mineral Resources

September 18, 1997

Representatives Present
Chairwomen Barbara Cubin (R-WY)
Ranking Member Carlos Romero-Barcelo (Res. Comm.-PR)
Rep. James A. Gibbons (R-NV)
Rep. Donna M. Christian-Green (Del.-VI)
Rep. Calvin Dooley (D-CA)
Rep. William "Mac" Thornberry (R-TX)
Rep. Chris John (D-LA)
Rep. Kevin P. Brady (R-TX)
Rep. John J. Duncan Jr. (R-TN)

Opening Remarks
The hearing began with Rep. William Thornberry (R-TX) stating his intent to "diminish the enormous resources spent in the audit and enforcement functions of collecting royalty-in-value." Thornberry criticized the Minerals Management Service (MMS) for its slow response to written questions posed in early August. (Answers were received the day before the hearing.) He stated that RIK is important for the country and if well structured, would reduce the size of the federal government. Thornberry went on to say that with the help of all interested parties, a program could be developed that would work. He concluded that "RIK is in the best interest of the federal government, industry and the taxpayers."

Ranking Member Carlos Romero-Barcelo (D-PR) was not as enthusiastic, saying that more analysis and assessment is needed before legislation is introduced. He quoted from a Congressional Research Service report that an RIK program would reduce administrative costs and disagreements over the value of oil and gas, but "such a system also would require an effective system for marketing the federal government's oil and gas and could lead to significant government involvement in oil and gas markets." Romero-Barcelo concluded by saying that it needs to be determined if an RIK program would be "feasible and fiscally sound" before any legislative steps are taken.

Panel I
William Henderson, Market Development Representative, Gulf Canada Resources Ltd.
Danielle Brain, Executive Director, Project on Government Oversight
Richard Rorschach, National Chairman, National Association of Royalty Owners
Ed Rothschild, Public Affairs Director, Citizen Action
Linden Smith, Managing Director, Barents Group
Timothy Cohalen, Esq., Cohalen & Koury
Bob Neufeld, Vice President, Environmental & Government Relations, Wyoming Refining Company

William Henderson testified that as the oil industry in Alberta, Canada was moving towards privatization in 1994, royalty systems were evaluated. RIK was found to maximize revenue with the least operational problems. Henderson explained that an RIK system has many benefits including revenue neutrality, avoidance of favoring production markets, and elimination of the need to interact with all owners of a producing facility. While RIK has been working well in Canada for oil, Henderson said that a royalty-in-kind system for gas would be "onerous due to the nature of the current sales and transportation commitments."

Danielle Brian began by saying that over the last few years it has become obvious that landowners and the public have been losing billions of dollars because of an "arbitrary and archaic system of posted prices which undervalues crude oil." Despite this statement, Brian was not in favor of RIK. She stated that companies should pay royalties based on open market value. Brian went on to say that a royalty-in-kind program would not address the real issue, which is a lack of competition at the wellhead. She acknowledged that there may be "unique circumstances where RIK could work," but concluded that the federal government should follow the lead of many states across the country and not use royalty-in-kind.

Richard Rorschach stated that RIK would be the best method to calculate royalties because such a system would determine a "fair market value" for the crude and it would involve the least amount of paperwork. He stressed the need for an "uncomplicated" approach saying that marginal well owners would shut down if the system was too complex. Rorschach concluded by saying that the goal of a royalty program should be "fair, accurate, and workable pricing" and an RIK program, "where feasible, will meet this goal."

Ed Rothschild began by saying that there was no interest in RIK until the Minerals Management Service proposed changing the valuation method for the collection of royalties on oil and gas. He warned that while RIK may work in some cases, it is not a "one-size-fits-all" program. According to Rothschild, RIK may be appropriate for natural gas but it is not appropriate for oil because it cannot assure competitive prices.

Linden Smith argued that a royalty-in-kind program could provide a "net benefit" to the federal government, states, lessees if well designed. According to Smith, a well-designed RIK program must be market driven, fair to all parties involved, recognize values added after production such as transportation costs, and must avoid "economic distortions." Smith concluded by saying that a well-structured RIK program can "increase economic efficiency, maintain federal and state revenues, reduce controversy, and be regarded as a fairer approach for federal and state governments, lessees, and the Nation's taxpayers."

Timothy Cohalen testified that with many companies in California merging, large companies will control the price of oil and it is "unlikely that a manageable and practical" RIK system could be developed. Cohalen felt it would be dangerous for a national policy to be developed that could have detrimental impacts on local markets.

Bob Neufeld expressed his dislike of the Minerals Management Service saying it was driving his company, Wyoming Refining, to bankruptcy and the company's "demise" would greatly impact the economics of the area. The comp any is currently involved in a lawsuit with MMS over allegations that the Minerals Management Service has the right to retroactively increase prices for oil purchases made over the last eight years. MMS is seeking almost seven million dollars for oil the company purchased that was "undervalued."

Rep. Romero-Barcelo agreed that there are benefits of royalty-in-kind but also risks that must be analyzed before going ahead with such a program. Romero-Barcelo then asked the panel to comment on the risk s of an RIK program. Danielle Brian explained that RIK would not fix the real problem of a lack of competition. Richard Rorschach said he did not think there were any "big risks." Ed Rothschild stressed that such a program may work in some areas but not in others because it is not a "one-size-fits-all" program. Linden Smith felt that the biggest risk would be moving too quickly. A royalty-in-kind program should be carefully structured with extensive industry involvement during the design phase. According to Timothy Cohalen, a big risk is the possibility of substantial revenue loss. Bob Neufeld felt any program would be better than the current one and saw no risks associated with RIK.

As questioning continued, the panel remained split on many of the issues. A common thread was evident though, as most of the panel agreed that a royalty-in-kind program had to be well structured or it would not work. Rep. William Thornberry (R-TX) focused many of his questions on the current and apparently successful RIK program used in Alberta, Canada. According to William Henderson, studies done before implementation of the RIK program showed it to be the best alternative. Chairwomen Barbara Cubin (R-WY) criticized many of Danielle Brian's remarks, which she felt implied that the subcommittee was not considering what program would maximize revenue for federal and state governments and taxpayers. Cubin continued by expressing her belief that the subcommittee was in fact working in the best interest of the nation. She suggested that a pilot program, modeled after the Canadian program, could be an option to dispelling skepticism concerning RIK. Linden Smith applauded the subcommittee's efforts saying that detailed legislation was needed to force the Minerals Management Service to take action.

Panel II
Robert Brown, Associate Director, Minerals Management Service Department of the Interior

Robert Brown testified that in order for a royalty-in-kind program to be in the "best interest of the United States," it must create revenue enhancement and neutrality and it must provide administrative relief for MMS and industry. The MMS report, Final Report of the 1997 Royalty in Kind Feasibility Study, was released in early September and concluded that RIK could be "workable." Brown stressed that it would not be wise to develop legislation until economic analyses are completed. Rep. Thornberry asked Brown to comment on the commitment of MMS to working with the industry to develop a successful RIK program. According to Brown, MMS is willing to begin work immediately on pilot programs but is not ready to commit to RIK legislation. He continued by saying that MMS does not intend to push for a legislative proposal because it does not feel that legislation is needed. Chairwomen Cubin asked Brown when an MMS report analyzing the cost to MMS of the current program would be available. Brown was unsure but responded that it would be available "soon." Cubin concluded the questioning by expressing her concern that the results of a pilot program may not reflect how a national program would work, especially in the absence of legislation. Brown assured Cubin that if a pilot program was unsuccessful, MMS would take into consideration all circumstances before immediately deciding against RIK.


House Hearing on H.R. 3334, the Royalty Enhancement Act of 1998

House Committee on Resources

Energy and Mineral Resources Subcommittee

March 19, 1998

Witness list
The Honorable Jim Geringer, Governor of Wyoming
Ms. Cynthia Quarterman, Director, Minerals Management Service
Mr. Hugh Schaefer, Director, Welborn, Sullivan, Meck, Ampersand, and Tooley
Mr. Poe Leggette, Esquire, Jackson and Kelly
Mr. Phil Hawk, President and CEO of EOTT Corporation

Members Present
Subcommittee Chair Barbara Cubin (R-WY) Chairwoman Barbara Cubin (R-WY)
Ranking Member Carlos Romero-Barcelo (D-Virgin Islands)
Mac Thornberry (R-TX)
Kevin Brady (R-TX)
Calvin Dooley (D-CA)
Chris John (D-LA)

Opening Statement
Chairwoman Cubin opened the hearing by recognizing that "significant changes in the manner in which some four billion dollars of oil and gas royalties are collected each year must be scrutinized carefully... but I am not willing to sit back and do nothing." She voiced her support for the bill and added that she has submitted it to the Congressional Budget Office and has "no intention of moving a bill that does not score positively under the rules of the CBO." Subcommittee Ranking Member Romero-Barcelo stated that the Democrats on the Committee have not yet taken a position on the legislation. They realize that the Administration has threatened a veto and want to work to create a compromise. Bill sponsor Rep. Thornberry noted that he intended his bill to begin a "simpler, fair system that benefits everyone" and was looking forward to constructive criticism.

Testimony
Panel 1
Governor Geringer testified in support of the bill, both in his role as governor and as chairman of the Interstate Oil and Gas Compact Commission. He believes H.R. 3334 would:

Geringer continued by stating that a successful RIK program would use a Qualified Marketing Agent (QMA) and allow state governments to act separately from the federal government. The goal should be to reduce costs, and will have the added benefit of increasing production from marginal wells.

Director Quarterman took a much different approach in her testimony. She stated that the government is already permitted under existing regulations to take royalty in kind and therefore "strongly opposes any legislation mandating the US to take its mineral royalties in kind and would recommend that H.R. 3334 be vetoed if presented to the President." MMS is "excited by the potential to streamline and improve aspects of our royalty collection and verification process" but "RIK is unproved and risky for royalty collection in the US." Quarterman contends that H.R. 3334 would force the US to relinquish many of its long-established legal rights as lessor while relieving lessees of many of their legal obligations. For example , the federal government would assume costs of marketing oil and gas. In addition, H.R. 3334 would mandate RIK programs in areas where unfavorable conditions exist-- such as taking de minimis volumes in remote areas, taking production at less than marketable conditions, and paying above market rates for transportation -- "ensuring a loss of revenue from these areas." Quarterman spoke briefly about pilot RIK programs in Texas, Wyoming, and the Outer Continental Shelf and her desire to wait until these projects have been completed to begin a mandatory RIK program.

Question and Answer
Chairwoman Cubin began by asking Governor Geringer about the results of the pilot study in Wyoming. He responded that the costs to the state are only 1/7 of current costs. He continued by stating that the Department of the Interior is not open with costs. Quarterman responded by stating the MMS has provided the states with a detailed breakdown of costs, and would be happy to meet with Geringer to discuss any questions.

Rep. Thornberry told Quarterman that there were several parts of her testimony that he believed did not address the final bill, but rather an earlier industry version. He cited her complaint that the bill would mandate that the government take RIK in unfavorable markets as one example and stated that the final bill had no such provisions. He then expressed his confusion over several different reports on whether MMS can currently take RIK. Quarterman responded that the government can.

Rep. Brady asked Quarterman about her assertion that H.R. 3334 would cost tax payers $500 million. He inquired if that figure assumed best marketing and the resulting lower regulatory costs. Quarterman responded that the figure does assume best marketing, and the Wyoming pilot project tried both QMAs and competitive bidding to determine the effect of marketers. With regards to lower regulatory costs, Quarterman stated that it assumes a $6 million deduction but does not include administrative savings .

Rep. Cubin joined Thornberry in asserting that Quarterman's remarks were "inadequate" and did not address H.R. 3334 and asked her to testify again at a hearing on March 31. Brady and Thornberry questioned Quarterman on how she arrived at the $50 0 million cost of the legislation. She stated that transportation costs would be the highest, and were estimated to be between $97.5-$246 million. Processing would incur the next greatest cost, followed by marketing. The study did not include any increase in value due to uplift or reduced litigation costs. Quarterman concluded the questioning by answering Brady's question: "Is it a completely negative analysis of RIK with no positive benefits?" with a resounding yes.

Panel 2
Mr. Leggett e gave a brief history of RIK before criticizing MMS by stating that "for MMS to say their rules are simple and certain is simply and certainly inaccurate." He stated that independents support RIK and H.R. 3334 because it will result in lower prices. He suggested that companies would redirect royalty payments to research and development. He also noted that the "level of distrust between the federal government and lessees has never been greater," making it difficult to successfully negotiate changes in policy.

Mr. Hawk testified on behalf of EOTT Corporation, a large independent crude oil gatherer and marketer, in support of H.R. 3334. He believes RIK using a QMA "is the best way to provide the federal government and the MMS with a fair market value for its crude oil." He also believes it would lower administrative costs for both government and industry because it would create certainty in the price and reduce the need for audits. He concluded by stating the need to maintain RIK over time and not allow changes on how royalties will be taken.

Mr. Schaefer testified that the current royalty regulations are "complex, difficult to administer, and vague and uncertain in many other respects." He spoke extensively about audits and difficulty in appealing these decisions. He concluded by supporting an RIK program that would eliminate many of these problems.

During a brief question and answer session, both Leggette and Schaefer responded that RIK would be beneficial to both marginal producer s and the government because the government could aggregate oil and gas to receive higher returns. Hawk explained that aggregating spreads the fixed costs over more oil and gas.


House Hearing on H.R. 3334, the Royalty Enhancement Act of 1998 (Part II)

House Committee on Resources

Energy and Mineral Resources Subcommittee

May 21, 1998

Subcommittee Chairwoman Cubin opened this second hearing on H.R. 3334 by remarking that the debate on royalty collection has denigrated to a "name calling between government and industry." She urged the Administration to cooperate in finding a solution to royalty valuation, and threatened to withhold funds in Fiscal Year 1999 if negations did not progress. Ranking Member Barcelo said that the Administration strongly opposes H.R. 3334 because it would cause the Treasury to lose $367 million per year. Rep. Thornberry-- the bill sponsor-- said that he hoped to "find a better way" to collect royalties through his legislation, which should be marked up in early June.

MMS Director Cynthia Quarterman cited the report of the Linowes Commission, which recommended creating MMS and advised that the "oil and gas industry should carry out its obligation, as lessee, to pay royalties in full and on time." She stated that H.R. 3334 would eliminate the government's choice in how to take royalties, which would "deny the public its rights under the lease and ultimately return less than fair value." She listed several factors that would contribute to the high cost to the government of the regulation: transportation, processing, treatment, and marketing. She also said that several states including Texas, New Mexico, Louisiana, California, and Alaska have voiced concern about the legislation. She concluded by again stating her opposition to the bill.

Former Wyoming Senator Malcolm Wallop, who now serves as Chair of the Frontiers of Freedom Institute, spoke about a report commissioned by his institute to study the issue of oil royalty valuation. The report found that royalty in kind could be effective, and he cited the success of a similar program in Alberta, Canada.

Mr. Roger Vicenti, acting president of the Apache Tribe, stated that the government should be able to take royalties however it chooses, and this legislation would prevent that. He does not believe that tribes would be affected by this legislation, but cautioned that it may end up negatively affecting them in the future.

Cubin began the question and answer session by asking Wallop about h is past dealings with MMS. Wallop replied that MMS's interpretations of regulations are often subjective. He also stated that Quarterman's testimony shows that MMS has "no knowledge of industry." In response to a question by Barcelo about the effect of the Hutchison amendment to prevent the implementation of the rule, Quarterman stated that the delay will cost the government $66 million per year. Cubin responded that the Congressional Budget Office (CBO) had scored the amendment as zero cost.

Thornberry asked Quarterman if MMS would support HR 3334 if it were changed to receive a positive CBO score. She replied that MMS can already take royalty-in-kind, and it is difficult to address hypothetical issues. Cubin and Thornberry disagreed with Quarterman's analysis of the costs associated with the legislation.

After a recess for a vote, the second and third panels followed with many representatives from industry, including many who had testified at previous hearings. For more information, please contact the AGI Government Affairs Program.


Senate Oversight Hearing on Federal Oil Valuation Regulations of the Minerals Management Service

Senate Energy and Natural Resources Committee

Energy Research, Development, Production and Regulation Subcommittee

June 11, 1998

In early May 1998 Senator Kay Bailey Hutchison (R-TX) introduced an amendment to H.R. 3579 to include a provision that stalled the implementation of the Department of the Interior's Minerals Management Service (MMS) proposed changes to oil royalty valuation.  The amendment postponed the publication of the new valuation rules until after that start of the next fiscal year on October 1, 1998.  As the deadline nears, the pressure on the MMS and Congress to move ahead is increasing.  Debate over MMS regulations has taken two roads: the potential of taking royalties in kind and the fair valuation of crude oil royalties.  Both the Senate and the House of Representatives have bills pending in committees on the MMS regulations.  The latest action on oil valuation was a Senate Energy and Natural Resource Subcommittee on Energy Research, Development, Production and Regulation oversight hearing.

Chaired by Senator Don Nickles (R-OK), the subcommittee met to examine the status of MMS efforts to revise oil valuation regulations.  In opening statements, the members of the committee agreed on the need for royalty valuation to be fair for the tax payers and the oil companies.  Senator Mary Landrieu (D-LA) called for a federal land lease royalty payment system that is neither overly complex nor overly simplistic.

Senator Barbara Boxer (D-CA) testified before the subcommittee on the importance of fair oil valuation to the education budget in many states, including California where oil royalties are credited to the State Schools Fund.  Concerned over the law suits filed by the Department of the Interior against major oil companies for back royalty payments, Boxer declared that it was time to allow the MMS to proceed with its "simple and common sense solution."

Full written testimony of the hearing witnesses is available at the Committee website.

Robert Armstrong, Assistant Interior Secretary for Land and Minerals Management, explained to the subcommittee members that "the Department's rule was not done overnight" but rather represented "an extensive rulemaking effort" between the MMS and its constituents in the industry.  The proposal, he said, "would reduce reliance on posted prices for royalty valuation, reflect true market value, provide certainty to all involved, simplify royalty valuation, reduce the need for audit, minimize royalty disputes, and provide maximum flexibility to adapt to changing market condition, and assure that the taxpayers of this nation get a fair return for their oil and gas resources."

Armstrong pointed out that the new rules would only affect 5% of the companies, mostly integrated companies, those having exploration, production, and refining divisions under one management, paying royalties to the federal government.  These integrated companies produce 68% of the royalties collected from federal lands.  Proposed MMS rules would not change regulations for independent companies that sell oil at arm's-length. Many key oil-producing states have supported the MMS proposal to use an indexed price for royalties.  The MMS would like to move forward on this proposal and on royalty-in-kind projects but cannot do so until the Interior Department appropriation bill is passed by Congress.

James Svenvold, Executive Vice President of SPN, Ltd., discussed the inadequacy of indexing crude oil prices to reflect localized market conditions.  Summarizing the proposed MMS rule changes as intending to "reflect the true market value," Svenvold stated royalty values should be based on the value of local lease markets, not a market index price.

Diemer True , Chairman of the Independent Petroleum Association of America's (IPAA) Land and Royalty Committee and partner of the True Oil Company, submitted his written testimony and exhibits to the records but was not present at the hearing.  In his place, Tom White of Vision Resources was present to give testimony  on behalf of the IPAA from Diemer True's statement.  White opened by saying that the recent downturn in the global oil market along with the current MMS oil valuation rules "has exposed America's half-a-million low-volume marginal wells at great risk."  Rebutting Assistant Secretary Armstrong's comment on the cooperation between MMS and constituent industries, White said that MMS has ignored the industry's suggestions on "valid arm's-length transactions at the lease."  He stressed the industry's desire to protect gross proceeds at or near the lease for arm's-length transactions.  Three suggestions were made: 1)  MMS should remove the duty to market rule because of the high cost for downstream marketing, 2)  MMS should restore a benchmark for legitimate arm's-length transactions at or near the lease, and 3)  MMS should remove uncertainty associated with gross proceeds at the lease.  White emphasized the industry's request for a royalty-in-kind (RIK) program as a fair program for federal royalty payments.

M. Brian McMahon , a partner in the law firm of McMahon & Spiegel, Los Angeles, California, on behalf of the City of Long Beach and the State of California, testified regarding the current system of oil valuation in California.  Criticizing the major oil companies for the current crisis in crude oil valuation, McMahon said prices based on major oil companies' posted prices are persistently below market value because the posted prices do not reflect true market value.  Supporting the MMS proposed oil valuation on publicly available market prices would base oil royalties on true market price.  On the subject of RIK, McMahon commented on his experience in California, that a "mandatory royalty-in-kind legislation is fatally flawed because it falsely assumes major oil companies will bid above their posted prices."

After the testimony, there was a short period for questions.  Referring to a press meeting held by Senator Boxer and Assistant Secretary Armstrong, Senator Nickles told Armstrong that political activity like the press meeting does not help to speed up the process of fair oil valuation.  Senator Nickles then asked if Armstrong believes that the oil companies are trying to "cheat" the MMS, to which Armstrong responded that the MMS has filed several lawsuits against major oil companies, and over the last 18 years MMS has collected nearly $2 billion in back payments from such law suits.  Continuing to challenge the fairness of the MMS proposed valuation, Nickles restated his belief that a mandatory RIK program is the best solution to oil valuation and royalty payments.  Armstrong voiced concern over collecting all federal royalties in kind without allowing the MMS to assess the RIK pilot programs which have not been allowed to proceed.   Later in the discussion, Senator Craig Thomas (R-WY) said his understanding of the RIK pilot program in Wyoming was that it was designed to fail.


House Mark-up of H.R. 3334, The Royalty Enhancement Act of 1998

House Committee on Resources

Energy and Mineral Resources Subcommittee

June 18, 1998

Earlier this year, Representative William "Mac" Thornberry (R-TX) introduced H.R. 3334 , The Royalty Enhancement Act of 1998, which was referred to the House Resources Subcommittee on Energy and Mineral Resources.  On June 18, 1998 the subcommittee, after several hearings on the matter, held a mark-up session of the bill.  Rep. Thornberry introduced an amendment in the form of a substitute to help clarify language regarding transportation and processing.  Two amendments to the Thornberry substitution were introduced by Rep. Cubin and Rep. Kevin Brady (R-TX).

The Thornberry amendment would not effect transportation allowances, so that, if under the royalty-in-value system an oil producer received a transportation allowance, then they will continue to have such an allowance.  Also, any extraordinary allowances granted before the implementation of the RIK program will be recognized under the RIK program.  "Transportation of water in the movement of bulk, unseparated oil production [from] outer continental shelf leases" will not be the responsibility of the federal government.

Rep. Cubin introduced an amendment to the substitution that exempts marginal wells and wells in remote locations from the mandatory RIK program, allowing these wells to continue under a royalty-in-value program.  The amendment also exempts the federal leases in Alaska from the RIK program because a federal RIK program would compete with the state's RIK program.

Rep. Barry introduced an amendment that clarifies extraordinary processing situations.

The revised Thornberry bill along with the two amendments were easily passed by the subcommittee and will be placed on the schedule for a full committee mark-up after the committee receives a report from the Congressional Budget Office on the financial implications of the RIK bill.


Meeting on MMS's proposed oil royalty valuation rule at Senate Russell Building

Roundtable Discussion

July 9, 1998

In an effort to expedite changes in proposed Mineral Management Service (MMS) regulations, several senators brought together representatives from the oil industry and the Clinton Administration for a roundtable discussion on July 9, 1998.  Participants included:

Diemer True, True Oil Co.
Claire Farley, Texaco North American Production
Thomas P. White, Vision Resources, Inc.
Victor G. Beghini, Marathon Oil Co.
Jack E. Little, Shell Oil Co.
Robert L. Keiser, Oryx Energy Co.
J. Larry Nichols, Devon Energy Co.
Cynthia Quarterman, Director MMS
Bob Armstrong, Assistant Secretary for Land and Mineral Management
Sen. John Breaux (D-LA)
Sen. Pete Domenici (R-NM)
Sen. Mary Landrieu (D-LA)
Sen. Jeff Bingaman (D-NM)
Sen. Don Nickles (R-OK)

Senators Breaux and Hutchison, co-chairs of the Congressional Oil and Gas Forum, invited the participants to the meeting in hopes of finding common ground between the different sides.  Generally, the oil industry is in support of an overall royalty-in-kind program, whereas MMS is hesitant to require all oil and gas royalties be taken in-kind, instead supporting a change in oil valuation regulations to reflect fair market value.  Before the meeting, the senators questioned MMS and oil companies about "whether the proposed rule establishes workable benchmarks to value oil produced on federal lands, whether it establishes a realistic approach to deductibility of transportation, processing and marketing costs and whether a reliable, consistent and binding guidance process has been evolved."

Senator Breaux, facilitator of the discussion, stated that his "purpose of holding the meeting was to bring together those concerned by the disputes and controversy over MMS's proposed oil royalty valuation regulations."  The roundtable is one of the few times that all parties discussed concerns face-to-face.

After Mr. Breaux's opening remarks, Senator Domenici, present at the request of Senator Hutchison who was not able to attend, commented on the need for the dispute to be "resolved reasonably" but continued by saying that all parties have "a long way to achieve this goal."

Mr. Armstrong, Assistant Secretary for Land and Minerals Management, quickly summarized the proposed changes: "If a lessee sold its production [at] arm's length, its gross proceeds under that sale would represent royalty value. If production were not sold at arm's length, royalty value generally would be an index price adjusted as appropriate by location, quality, and transportation factors."

Representatives from oil companies voiced concern over problems in transportation costs and allowances.  Cynthia Quarterman, MMS Director, explained that "under current valuation rules, lessees can deduct their reasonable, actual costs of transportation," a regulation that would not change under the new proposal.

Complete meeting notes on the July 9th roundtable discussion and MMS publications of the proposed valuation regulations are available in PDF format at the MMS reading room.


Roundtable Discussion on Proposed MMS Regulations Sponsored by Representatives George Miller (D-CA) and Carolyn Maloney (D-NY)

Capital Building

July 21, 1998

Participants present at the Roundtable Discussion:

Courtney Cuff, Green Scissors (Friends of the Earth)
Ralph DeGennaro, Taxpayers for Common Sense
Danielle Brian, Project on Government Oversight
Brian McMahon, City of Long Beach
Anna Amillio, U.S. PIRG (Public Interest Research Groups)
Hank Banta, California Comptroller's Office
George Miller, U.S. Congress (CA-7th)
Carolyn Maloney, U.S. Congress (NY-14th)
Perry Shirley, Navajo Nation
Alan Taradash, Jicarilla Apache Tribe
Cynthia Quarterman, Director of the Mineral Management Service
Bob Armstrong, Assistant Secretary for Land and Minerals Management
Debbie Gibbs Tschudy, MMS
Claire Milner, California Department of Education
Andrew Rotherham, American Association of School Administrators

This meeting, unlike the previous Senate roundtable discussion, was opened to the public, allowing environmental groups and effected education groups to voice their concerns directly to the MMS administration.  It was held by leading House Democrats, including Rep. Miller the Ranking Member of the Resource Committee, who oppose the proposed Royalty-In-Kind legislation, and call for an end to the delays, like the Hutchison rider and endless meetings, keeping the new MMS regulations from being implemented in October.

Rep. Miller stated that "we are holding this meeting in response to Mr. Armstrong's decision to reopen the public comment period on the proposed rules so that the Department could comply with certain Senators' interest in brokering some sort of compromise on behalf of the oil companies."  He continued saying contrast to some members of the Senate, who are "asking for delay, negotiation or compromise, he and Rep. Maloney believe that MMS has been overly accommodating to the oil industry at the expense of school systems that directly benefit from oil and gas royalties.  Maloney echoed these concerns and brought up the concern of "backdoor" negotiations to delay the implementation of the proposed rules.

Mr. Armstrong, in his opening remarks, said that the issue of fair royalty payment is not new, and that the "Department has held 14 hearings and received over 4,000 pages of comments on the proposed rules over the last 2 1/2 years."  He closed by asking the attendees of the roundtable what topics they would like explained.
 
Several participants voiced concern about environmental damages caused by the oil industry.  Ms. Cuff, representative from Friends of the Earth, summarized the sentiments of many panel members by saying that the oil "industry should not continue to get the 'red carpet' treatment through the [Hutchison] rider."
 
Miller and Maloney discussed the definition of affiliate with Ms. Gibbs Tschudy, Chief of the Royalty Valuation Division of the MMS, who responded that MMS was proposing to keep the definition used in the current rule -- "that ownership between 10 and 50 percent presumes affiliation, with lessees offered the opportunity to rebut that presumption."  When asked if this language would lead to "endless litigation," Ms. Gibbs Tschudy replied that there have been few request to rebut the presumption and few problems with the language.
 
Mr. Shirley, representative for the Navajo Nation, questioned the panel about whether the Hutchison rider applies to Indian leases as well as Federal leases.  He continued by saying that fair oil valuation was a Federal, State, and Indian issue that the Department needs to not back down on the rules.

The panel also discussed the use of spot prices, posted prices, and market prices to set royalty valuation prices.  Ms. Gibbs Tschudy replied that "spot prices represent actual transactions between willing buyers and willing sellers in the market as opposed to posted prices that are set by the oil companies themselves."  She then said that after adjusting for location, market prices based on NYMEX and spot prices are basically equal.

The meeting ended after a brief discussion on deep ocean leases and environmental problems in the Gulf of Mexico.

Complete meeting notes of the July 21st open discussion and a press release from Representative George Miller are available in PDF format at the MMS reading room.


Senate Sponsored Roundtable Discussion on the Proposed MMS Regulations

Senate Dirksen Building

July 22, 1998

 
Sen. John Breaux (D-LA)
Sen. Pete Domenici (R-NM)
Sen. Mary Landrieu (D-LA)
Sen. Jeff Bingaman (D-NM)
Sen. Kay Bailey Hutchison (R-TX)
Sen. Craig Thomas (R-WY)
Cynthia Quarterman, Director of Mineral Management Service
Bob Armstrong, Assistant Secretary for Land and Minerals Management
Claire Farley, representative for Texaco North American Production
Diemer True, representative for True Oil Co.
Thomas P. White, representative for Vision Resources Inc.
Peter Robertson, representative for Chevron USA Co.
Robert L. Keiser, representative for Oryx Energy Co.
Jack E. Little, representative for Shell Oil Co.
George Yates, representative for Harvey E. Yates Co.
 
In response to Senator Breaux's request at the July 9th meeting, MMS, on July 16th, placed a Federal Register notice that addresses: 1) "the affiliate definition, 2) language added to the proposed rule on 'second guessing' lessees; marketing decisions, 3) requirements for applying gross proceeds under arm's-length sales following an exchange agreement, and 4) a request for comments on allowablitiy of gathering coast as transportation under certain circumstances."  Sen. Hutchison asked if the notice was a supplemental proposed rule; to which Ms. Quarterman replied that "the supplemental rule was meant to summarize those issues in which the Department had determined to move in the direction of industry as Senator Breaux requested."  Sen. Bingaman commented on the time restraints of the notice, the comment period was to end on July 23, and suggested MMS extend the comment period.  Despite attempts by MMS to implement the new regulations by October 1, 1998, Sen. Hutchison made it clear that she was looking at a publishing date of October 1999, and extending the comment period would work into that time frame.  Mr. Armstrong said the Department was trying to meet the Secretary's October deadline, but agreed that an extension for the comment period might be helpful as long as it does not lead to "meeting after meeting on this issue."  Before moving on to more specific topics, Sen. Bingaman "he understood that the Department's legal counsel warn that the Department can't have substantive talks with Senators or others on the rule after the comment period closes," and, with the support of Sen. Hutchison, expressed that this advice is another reason the comment period should be extended.  Mr. Armstrong said that he agreed but "at some point soon the issue must be wrapped up."

Mr. Little, representative from Shell Oil Co., said that the proposed changes were not a great improvement and MMS has not listened to the concerns of the oil industry. There has been some improvement in better defining affiliate, but there is still much work to be done on the issues of gathering, benchmarking, marketing costs, duty to market, and exchanges.  Several other representatives from the oil industry echoed Mr. Little's sentiments that the proposed changes are regressive and far from acceptable.

There was discussion on tendering programs that were supported by several representatives from the oil industry.  Ms. Farley, representative from Texaco, said that she believes that tendering programs at the lease will simplify the differences on transportation issues.  Ms. Quarterman, Director of MMS, responded to the tendering suggestions that "tendering is not set up to promote receipt of market value -- rather it is used for royalty payment purposes."  Oil industry representatives also called for multiple valuation options, including the option of a tendering program, that the proposed changes do not address.

At the end of the meeting, participants debated whether continuing the mediated meetings would help lead to an acceptable conclusion for all parties.  Senator Breaux stated that either Congress can vote on current proposed legislation, a "lose/lose situation" due to strong support on both sides of the issue, or continue to delay the regulations by actions similar to the Hutchison rider.  He suggested that the best solution is for the parties to continue to meet and talk.  Mr. Little suggested that MMS, for the next meeting and the general industry, summarize the ideas the industry proposed in this meeting.  Senator Breaux followed up by asking that MMS reply to these proposals in the summary.  Mr. Armstrong closed the meeting by saying that the Department has been working on these changes for nearly 3 years and "hadn't simply begun recently."

Complete meeting notes, preliminary responses from MMS to industry comments, agenda questions, industry recommendations, and other handouts from the closed meeting on July 22 are available in PDF format at the MMS reading room.


Meeting Between Senate Staff and the Department of the Interior Staff on Oil Valuation Proposed Rules

July 28, 1998

The meeting between Senate staff and Department of the Interior administrators was a chance for participants to discuss MMS's July 24, 1998, responses to oil industry suggestions from the July 22nd meeting.  Participants in the meeting included:

Karen Knutson, Legislative Assistant for Senator Hutchison (R-TX)
McLane Layton, Legislative Assistant for Senator Nickles (R-OK)
Bob Simon, Legislative Assistant for Senator Bingaman (D-NM)
Mike Poling, Natural Resources Counsel for the Committee on Energy and Natural Resources
Hank Kashdan, Counsel for the Interior Appropriations Committee
John Northington, Special Assistant to Assistant Secretary Bob Armstrong
Tom Kitsos, Staff Assistant to Assistant Secretary Bob Armstrong
Lucy Querques Denett, Associate Director of Royalty Management
Peter Schaumberg, Onshore Minerals Assistant Solicitor
Debbie Gibbs Tschudy, Chief of the Royalty Valuation Division (via telecom)
Dave Hubbard, Economic Valuation Branch Chief (via telecom)

The meeting quickly covered the issues that oil industry representatives proposed changes to in the pervious roundtable discussions: arm's-length contracts, multiple exchange agreements, tendering, duty to market, transportation, tariffs, and non-binding guidance.  Minutes of the meeting are available in PDF format at the MMS reading room.

At previous meetings, industry representatives had suggested that MMS provide several different "methods to value oil that is exchanged several times before it is sold at arm's-length," including an intermediary benchmark and a tendering program, so that oil companies can choose what method best accommodates their situation.  Department of the Interior (DOI) staff members voiced concerns with "lease-based benchmarks," but would take the suggestion into consideration.

Another important issue discussed was tariffs for onshore and offshore transportation.  Currently, FERC only has jurisdiction on onshore transportation tariffs, but Congress can pass legislation that would give FERC jurisdiction for both onshore and offshore tariffs.  Transportation tariffs have been a major concern for oil industry representatives. DOI staff said that the current proposal is to not accept tariffs for transportation from either onshore or offshore locations, because "tariffs significantly overstate a producer's-pipeline's actual costs."

Senate staff members asked if the Department would issue a new proposal based on the Congressional sponsored meetings over the last month.  DOI members replied that they would take into consideration the suggestions from the oil industry and Congress, but still would like to publish the new regulations by October 1, 1998.

Sources: Hearing testimony, Independent Petroleum Association of America, Environment & Energy Weekly, MMS website, the Library of Congress.


Please send any comments or requests for information to the AGI Government Affairs Program at govt@agiweb.org.

Contributed by Kasey Shewey White, AGI Government Affairs and Catherine Runden and Margaret Baker, AGI Government Affairs Interns.
Last updated November 5, 1998
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