Mr. Chairman and Members of the Subcommittee: We are pleased to be here today to discuss the Department of the Interior's procedures for collecting and accounting for oil and gas royalties due the federal government, states, and Indian tribes and allottees.1 In the past 30 years, numerous GAO and Department of the Interior audit reports and a blue ribbon study commission, commonly referred to as the Linowes Commission, have addressed the need for Interior to correct the long-standing management problems that have plagued its oil and gas royalty management program. The Congress has also called for improvements during numerous oversight hearings and reports. For instance, a comprehensive report by the House Committee on Interior and Insular Affairs in December 1984 highlighted serious continuing royalty management problems facing the department and presented a series of recommendations to correct those problems. The department has put forth major efforts over a number of years to improve its performance in this difficult and complex area. However, it continues to experience serious difficulties in the following critical areas: 1An Indian allottee is an individual who receives a royalty payment. --developing and publishing acceptable product valuation guidance, - implementing an effective accounting system for royalty collections and distributions, - verifying production through a viable lease inspection program, and establishing an adequate auditing program to check on the accuracy and completeness of the industry's royalty payments. Before proceeding further, I would like to point out that our current assessment is based primarily on a monitoring effort which we are performing at the request of the Chairman of the House Committee on Interior and Insular Affairs and work for the Chairman of the House Appropriations Interior and Related agencies. These efforts have not included any system or transaction testing or other in-depth work. OVERVIEW OF THE EXISTING SYSTEM Following the issuance of the Linowes Commission report in 1982, Interior established the Minerals Management Service (MMS) to administer the royalty management program and to ensure that the proper amount of royalties is being collected. While MMS has the primary responsibility for royalty management, the Bureau of Land Management and the Bureau of Indian Affairs have certain responsibilities regarding leasing, site inspection, and disbursement of royalties to Indian tribes and allottees. Royalty accounting is complex by nature. Royalties are not paid on the basis of production but on sales, typically after the product has been processed. The fact that a number of companies are often on one lease further complicates the process. At the time of sale, the industry establishes a value which takes into account processing and transportation allowances and the market price for the product. The royalty is then computed and paid by the company. Tracking production and verifying the royalty calculation through this maze is difficult. Also, industry-calculated payments are accepted as correct unless MMS determines otherwise through its accounting system and audits. As an illustration: Oil or gas is pumped out of the ground at the wellhead and the leasing companies report production volume to the department. The oil or gas is transported to a processing plant, creating a transportation cost allowance which is calculated by the industry and can vary from lease to lease. After the oil or gas is processed, the industry calculates a processing cost allowance which can vary based on the plant involved and the quality of oil or gas. The finished product is sold. The industry calculates the value of the finished product, taking into account transportation and processing cost allowances as well as the market price for the product, and computes its royalty payment. - The industry reports the sale of its finished product and sends the royalty to MMS. MMS accepts the payment and disburses royalties to the respective states or the Bureau of Indian Affairs. MMS relies primarily on audits to identify underpayments. |