LACK OF ACCEPTABLE PRODUCT A continuing problem is determining the proper value of oil and gas for purposes of calculating royalties. The Linowes Commission reported in 1982 that improper valuation was the primary factor for royalty underpayments. Also, valuation problems account for about $110 million of the $261 million in underpayments identified through MMS audits between October 1981 and August 1986. Existing valuation regulations are complex and subject to varying interpretations. Most audit exceptions to royalty calculations by the industry are due to differing interpretations of the regulations, which can end up in litigation. Proposed revisions to Interior's valuation regulations, including NTL-5, are unlikely to resolve the complexity of valuation issues. In addition, the revisions may not be agreeable to states and Indian tribes and allottees who will receive reduced royalty payments under the proposed industry cost allowances. LONG-STANDING SYSTEM PROBLEMS PRECLUDE ADEQUATE ROYALTY ACCOUNTING The development of an adequate accounting system also continues to be a serious problem. We first reported in 1959 that Interior did not have an adequate royalty accounting system. Unverified data were used to compute royalties, and lease records contained numerous errors and omissions. In 1979, faced with both growing criticism of its inability to adequately account for royalty payments as well as reports that millions of dollars of royalties were not being collected, the department began developing a new automated royalty accounting system, called the Auditing and Financial System. This system is the primary vehicle used by MMS today to collect, account for, and disburse oil and gas royalties received from the about 25,000 producing leases. In January 1983, we issued a report2 to the Secretary recommending that the system not be implemented on February 1, 1983, as planned, because of inadequate system documentation, unclear user requirements, inadequate testing, and other unresolved problems. However, the department went ahead with its 2Interior Should Solve Its Royalty Accounting Problems Before Implementing New Accounting System (GAO/AFMD-83-43; January 27, 1983). plan to implement the system, without first resolving these matters. Since then, the system has experienced numerous problems which, for the most part, can be traced to inadequate computer capacity. Because of its inadequate capacity, the system cannot process the accounting data or produce reports necessary to ensure that the proper amount of royalties has been paid. In April 1985, MMS contracted for the conversion of the system to a larger computer. The conversion, originally slated for December 1985, has slipped to July of this year. After conversion, we believe MMS should further enhance the system so that it better satisfies information needs of the federal government, states, Indian tribes and allottees, and the industry. INSUFFICIENT VERIFICATION OF PRODUCTION To assist in verifying royalty payments, the accounting system should compare industry reports of oil and gas production from leased fields with industry data on sales volume that are subsequently reported at the time the royalty is paid. However, the department is unable to effectively verify royalty payments for the about 23,000 onshore leases3 because it does not have a 3There are about 2,000 offshore leases. system in place to make the necessary comparison between production and sales volume. A principal problem has been the complexity of such a system and the accompanying costs and paperwork burden it would place on the oil and gas industry. The House Committee on Interior and Insular Affairs, in its 1984 report, advised MMS to reassess its requirements before proceeding with full-scale implementation of such a system. To date, MMS has not been able to resolve the concerns raised. Another problem with verifying royalty payments is the insufficient number of Interior field inspectors who must monitor production in the leased fields. For example, the Bureau of Land Management has about 100 inspectors who monitor the about 23,000 producing leases and about 100,000 nonproducing leases. These inspectors also have collateral duties to protect the environment and to monitor security and safety. AUDIT RESOURCES ARE INADEQUATE The Department of the Interior also does not have enough auditors to verify the accuracy and completeness of the industry's royalty payments. Although auditing is the principal internal control, MMS only has about 175 auditors to review the 25,000 producing leases. The Director of MMS has mandated that each lease will be audited at least once every 6 years. Under the most optimistic circumstances, this work load will only allow each auditor about 2 weeks to review a lease, which requires examination of leasing agreements, contract provisions, accumulation and allocation of processing costs, product valuation, and royalty calculations. In conclusion, the department has worked hard to strengthen royalty management. While there has been progress, problems remain. This effort must continue to receive a high priority, including necessary funding for accounting systems development, inspection, and auditing. In addition, the department must search for solutions to some of the fundamental accountability problems we have outlined today. New approaches to simplify the process should be explored since determining the proper royalty at the point of sale and the related accounting have been continuing problems. We stand ready to work with the Congress and the department in this endeavor. Mr. Chairman, this concludes my remarks. We would be pleased to respond to any questions you or members of the Subcommittee may have at this time. |