Drilling For The Truth: More Information Surfaces On Unpaid Oil Royalties
Table of Contents
Global Settlements: "Not the Sort of Deals You or I Would Make"
Leaving Native Americans Behind
The Inspector General Report
"The Fix May Be In"
Warnings Not Heeded: The Linowes Commission
After our initial Freedom Of Information Act (FOIA) requests from September 21 and 26, 1994 to various offices within the Department of the Interior (DOI) for "all audit reports, issue papers, memoranda, studies, analyses, work papers and notes . . . regarding the pricing and valuation of California crude oil since 1980," we have finally received what they claim to be the last of the documents. During this period, the Project On Government Oversight (POGO) has received thousands of pages of documents through the FOIA, and we have issued three previous reports on the topic.1
It comes as no surprise that it took so long for these final documents to be released. They paint a picture of an agency violating the public trust and working hard to keep the truth from the public and Congress. As part of a larger effort to cover up the Agency's relationship with the oil industry, DOI knowingly entered into deals that forfeit hundreds of millions of dollars owed to the public. This revelation comes after the DOI acknowledged recently that the major oil companies do, in fact, owe the federal treasury significant amounts of money from underpaid royalties on crude oil production from federal land -- a turnaround after decades of ignoring the problem.
After working with POGO on this issue, Representative Carolyn Maloney (D-NY) requested a Congressional hearing on this subject. In June 1996, the House Subcommittee on Government Management, Information and Technology held a hearing. The Director of the DOI department responsible for royalty collection, the Minerals Management Service (MMS), Cynthia Quarterman, confirmed that the facts in POGO's earlier reports were correct.
After several years of POGO's prodding, in September and October 1996, DOI sent out bills for $385 million in unpaid royalties to oil companies operating under federal leases in California.2 This $385 million is just a portion of the total amount of unpaid royalties owed to the American public by oil companies -- at least $856 million is owed from oil production in California alone since 1978, and as much as $1.5 billion is owed dating back to 1960. This means DOI is not even attempting to collect a potential $1.1 billion owed from oil produced on just California federal lands.
Royalties the federal government collects from oil production in California represent just a small portion of the total amount of royalties the federal government collects annually -- in fact, 90% of the royalties that DOI did collect from 1985 to 1995 came from federal land outside of California. According to DOI testimony at the Congressional hearing, oil companies' undervaluation of crude oil produced East of the Rockies led to the underpayment of royalties by from 3% to 10% from 1985 to 1995.
Based on this DOI testimony, POGO estimated that, outside of California, oil companies owe the American public an additional $400 million to $1.3 billion in unpaid oil royalties since 1985, excluding interest and penalties, for oil produce East of the Rockies.3
Rep. Maloney estimates that at least $200 million of the money owed by the oil companies is considered "forgiven" by the Department of the Interior as a result of the "global settlements" discussed in the next section of this report. Maloney questions the legal authority of MMS to enter into these global settlements in the first place.
MMS announced that it was going to begin collecting money, but explained it could not collect the full $856 million owed from California production by adding the caveat:
That estimate must be discounted to exclude revenues for the years 1978 and 1979, volumes of royalty taken in-kind, crude oil production attributable to periods closed by settlement agreements, and for differences in valuation methods beginning March 1, 1988.4
In October 1996, when DOI released their Summary of Additional Royalty Due, they zeroed out the amounts owed by Chevron and Exxon with the remark "Settlement" as the explanation for why no money will be collected from these companies. 5
Up to $2.4 billion remains uncollected -- and there is no evidence that DOI has any intention to try to collect this money. Why would a federal agency be so hostile to collecting money owed to the public?
Despite numerous internal DOI warnings that significant amounts of money owed to the public were being compromised, the DOI was moving forward with what was described internally as "California Royalty Secret Deals," by signing global legal settlements with Mobil, Exxon and Chevron.
Two years after POGO requested documents regarding oil royalty deals, we finally received materials containing clear indications of activities that were not in the public interest.6
In August 1993, the Director of DOI's Office of Policy Analysis, Brooks Yeager, was alerted to the California royalty issue in a paper prepared by his staff.7
In response to that paper, in October 1993, MMS completed an internal "scoping exercise" that determined as much as $422 million was owed in royalties as a result of the undervaluation of California crude oil from 1960-1992. The memo recommended that MMS "pursue potential Federal royalty payments." The $422 million figure did not include interest or penalties.8
Incredibly, despite MMS's own recommendation, less than two months later, on December 6, 1993, then-Director of MMS Tom Fry signed the global settlement with Exxon -- which included no specific provisions whatsoever to protect the government's ability to collect Exxon's share of the unpaid royalties, interest and penalties.9
During the Chevron settlement discussions, a March 1994 internal DOI phone log titled "Secure Information -- California Royalty Secret Deals," described an "anonymous" phone call to a staff member.
The call warned of ongoing "secret deals" with California oil companies: "not the sort of deals you or I would make." 10
The staff member noted reporting the call to a supervisor, and setting up a meeting with Brooks Yeager to discuss this warning.
Concerns about DOI's handling of this issue during the Chevron settlement discussions were also raised in an internal e-mail to Yeager:
You may wish to discuss the following with Tom Collier [Chief of Staff to Secretary Babbitt].
I am concerned that the Department and MMS lack of responsiveness and, in some cases, antagonism relative to the MLA [Mineral Leasing Act] Common Carrier and California Royalty issues may be reaching a level that may impair the Secretary's [Babbitt] relationships within the State, and the potential to negatively impact other initiatives. [emphasis added]11
Also in March, four days before the Chevron settlement was signed, a high-level meeting of DOI policy makers was called specifically about the California royalty underpayment problem. A handwritten document POGO obtained through FOIA, with most of the text blacked-out, was dated March 18, 1994, (the Chevron settlement was signed March 22, 1994), was titled "re: Cal. Royalty [Under]payment", and listed the participants as follows:
J. Leshy (John Leshy, Solicitor),
T. C. (Tom Collier, then-Chief of Staff to Secretary Babbitt),
T. F. (Tom Fry, then-Director of MMS), and
P. Schaumberg (Peter Schaumberg, Solicitor's Office).
The vast majority of the text of this document was withheld by DOI, claiming the FOIA exemption of "Deliberative, Predecisional and Attorney-Client."12
POGO has obtained, however, the uncensored version of this document.
The last entry in the documents may explain why this information was withheld from the public. It shows that Tom Fry reported to this group of high-level DOI officials -- four days before the signing of the Chevron settlement -- that he had "thought about" trying to get some money from Chevron on the California royalty underpayment issue up front. He had decided, however, "to close it out" because he believed the "Chevron global settlement is reserved on this issue" -- meaning that the public's right to collect money from the undervaluation of California crude oil had been preserved.13
At the same time this high-level meeting was taking place, an internal DOI phone log indicated Tom Fry also assured Brooks Yeager, "that the Chevron settlement would specifically exclude Calif."14
James Shaw, then-Associate Director for Royalty Management, was interviewed in the trade publication "Inside Energy and Federal Lands" about the California crude issue and its impact on the global settlement process. He also asserted his belief that the government would be able to collect the unpaid royalties despite the global settlements.
Shaw was quoted as saying, "As long as this issue remains open, I think common sense interpretation would be that all of our settlements would be conducted in the way the one with Chevron was -- that this issue would be excepted."15
These documents are fascinating because they show that the Director of MMS, the Director of the Policy Office, and the Associate Director for Royalty Management all claimed the government had retained the right to collect money from Chevron.
Ultimately, the Chevron settlement specifically absolved the company from having to pay owed royalties and interest before 1980, but provided that the government can collect unpaid royalties owed after 1980 if the posted prices are established "through collusion with third parties, fraud, or improper conduct which violates the lease obligations or the Mineral Leasing Act...."16
On March 24, two days after the signing of the Chevron settlement, the following notation was made in the internal DOI phone log:
Chevron global settlement signed 3/22/94 received here on 3/24/94. Only partial exclusion of Ca royalty issue (post1980), all pre80 matters on Ca considered settled. Yeager appeared bothered when presented with it & stated his understanding was that the whole issue was to be preserved, not just part of it.17
Currently, despite the understanding articulated by all the top DOI officials responsible for royalty collection at the time, DOI is no longer interpreting the settlement to allow for the collection of the money owed by Chevron.18
If, in fact, it is now the case that DOI cannot collect this money -- there has been a total breakdown of the system. The top three policy officials responsible for the global settlement and royalty collection processes claimed that the government's interests had been protected, at the time they were signed. The two top lawyers responsible for drafting the settlements also attended the high-level meeting and heard this policy call -- yet the notes did not reflect any disagreement with this interpretation of the settlements. Now, however, MMS and the Solicitor's Office have reversed DOI's position.
After the Chevron and Exxon settlements were completed, a DOI policy paper warned about Secretary Babbitt's potential exposure to "significant criticism" as a result of the DOI's handling of these settlements:
Global Royalty Settlements that MMS has been conducting may expose the Secretary to criticism for relinquishing claims to substantial royalty revenues. In addition to significant budget consequences, these problems also tend to raise program integrity issues as they usually get considerable attention by the press.19
Another controversial aspect of the Chevron settlement was highlighted in a draft December 1994 memo to Brooks Yeager. It warned that two Native American nations -- the Shoshone and Arapaho -- had not been included in the settlement discussions. Yeager was alerted to the fact that these nations felt their "issues had not been preserved" by DOI:
I have recently learned that additional oversights of the sort highlighted in my September memorandum continue to turn up. . . I understand that additional issues may have inadvertently been "settled" to the potential detriment of stake-holders. Specifically, the Shoshone and Arapaho tribes have raised concerns that their issues were not preserved and that they were not consulted during or after the settlement negotiations. [emphasis added]20
In September 1996, the DOI Inspector General confirmed that Native American interests had been overlooked during the global settlement process:
. . . the Service [MMS] did not offer two Indian tribes the options to negotiate their issues separate from Federal and state issues in one of the settlements or to participate in the negotiations of their issues for this settlement, although offering these options was required by the 'Negotiation Procedures'.21
DOI Assistant Secretary for Land and Minerals Management Bob Armstrong took exception with the characterization that DOI was insensitive to Native American interests in a February 6, 1997 letter to Representative Maloney:
Disputed issues involving tribal leases were a very small part of the settlement. While tribal representatives did not participate in the negotiating sessions directly, no issue involving tribal leases was compromised. All disputed tribal royalty issues were paid in full. The tribes were afforded an opportunity even after the settlements were concluded to review the amounts they were paid. No tribe had any objection to the amount it received.22
Rep. Carolyn Maloney responded to this explanation in a March 12, 1997 letter to Asst. Secretary Armstrong:
If you are correct that all disputed tribal royalties issues were paid in full, then at least in these two examples, the tribes were paid in full well after the settlement. Can you explain what money the government used to resolve these tribal issues?23
There has still been no response to this important question. If Chevron was not required to pay these two Native American Nations directly, did the money come from the already inadequate government funds collected for the general public?
In an unsigned DOI memo for the record, titled "Mobil Global Settlement Concerns," dated September 17 and 18 (presumably 1995, since the Mobil Global Settlement was signed by the DOI on September 25, 1995), concerns about DOI's failure to protect the public interest in the global settlements was yet again evident:
Source called to warn and express concern about course of negotiations in Mobil Global Settlement irregularities. Primary problem is that Mobil will be given full immunity from any offsets. Thus, even in the event that they are found to owe money, if the collection is time-barred by the courts, they are immune from administrative offset against refunds.24
In the end, the type of settlement negotiated with Mobil was changed from being a "global" to being an "issue" settlement, where not all outstanding issues were resolved. As a result, the government's right to collect unpaid royalties was not affected by this settlement.25
In September 1996, the DOI Inspector General finally publicly released their scathing report, "Negotiated Royalty Settlements, Minerals Management Service" -- nearly a year after the final draft of the Inspector General report had been completed. This report found the MMS Global Settlement process to be in a shambles. The report indicated that the concerns of the Policy Office, raised years earlier, may have understated the seriousness of the problem. The Inspector General report concluded:
. . . the Service [MMS] did not maintain sufficient information to substantiate that the settlements were negotiated in the best interests of the Government, states, Indian Tribes, and Indian allottees. . . . Specifically, for 9 of the 10 settlements reviewed, there was no documentation for the estimated values of the issues concerning the underpayment of royalties to be negotiated, the arguments for reducing the values, and/or the reasons why the values of issue were reduced as a result of negotiations. [emphasis added]26
As an example of the problems in MMS's handling of the settlements, the Inspector General Report found:
Prior to negotiations one of the Service's [MMS] Royalty Management Program divisions estimated the value of a particular issue to be negotiated in a global settlement to be about $439 million. However, the list of issues and values prepared by the negotiation team prior to negotiations estimated that the same issue was valued at $78.6 million. Documentation in the settlement file was insufficient to explain the $360.4 million difference in the estimated values of this issue. [emphasis added]27
In other words, even though the total estimated amount owed to the government, in this one case, was $439 million, for reasons that were not documented in MMS's files, MMS began negotiations at $78.6 million -- essentially writing off $360 million without even trying to collect it for the public. The report showed that of the settlements they reviewed, MMS could not justify resolving more than $1 billion in outstanding claims for only $218 million.
MMS's explanation for the lack of documentation was typical of their fear of outside scrutiny:
Service personnel (MMS) said that documentation was inadequate because they did not have sufficient personnel to perform this task and because they were concerned that release of this information under the Freedom of Information Act could affect future settlement negotiations with other royalty payers.28
In the past, DOI has certainly been very willing to exempt specific information that is "predecisional" or "attorney-client" from being released through FOIA. Now, however, DOI is feigning an inability to withhold sensitive information from public release as a convenient excuse not to keep records of the amounts owed to the public by the oil companies.
As it became more clear that DOI could not adequately represent the interests of the federal government, state governments and Native American tribes, an Interagency Task Force was created by Asst. Secretary Bob Armstrong. It included representatives from the Departments of Justice, Commerce, Energy and DOI to examine the issue of the underpayment of royalties for California crude.
As that Interagency Task Force was at work, the Director of MMS tried to curtail the evaluation of how much money was owed by the oil industry -- primarily to keep the public from finding out. A sensational November 30, 1995 memo from the Department of Energy (DOE) Task Force representative to the Chairman of the Task Force revealed this effort:
As you expect, I was somewhat amazed by your phone message stating that Cynthia Quarterman directed that we substantially abbreviate what we have been drafting for next week's decision meeting. According to your message, her main concern is preventing disclosure of our findings under the FOIA. But the records (drafts of the options paper, collectability estimates, etc.) have already been created and would be available for consideration under FOIA. . . .
The only logic I can put to this is that Ms. Quarterman wants deniability. That is, she wants to be able to say that she and other management never saw what we created. Frankly, if that is the reason, it will not hold water. . . .
Yes, I am sorry to see this happen because we both have wasted a lot of time on this paper, and I think it would have been a good one. Worse yet, the fact that DOI seems to be attempting to pull down the shades on this issue indicates that the fix may be in again as in 1986 and as with your paper a couple of years ago. [emphasis added]29
The recipient of this memo, Dave Hubbard, was not only the author of the first "scoping exercise" where he found as much as $422 million was owed by the oil industry, but as the last sentence of this memo points out, Hubbard also authored the subsequent policy paper in which he completely reversed his position, and stated that no money was owed to the public. As the Director of the Interagency Task Force, Hubbard also sent an e-mail to his supervisor, Jim Shaw, then-Associate Director for Royalty Management, asking for "some sort of 'motherhood' statement I can give the team for our next meeting -- I have stalled this issue long enough."30
In addition to this remarkable memo, DOI released through FOIA a copy of Appendix 4, entitled "Companies' Use of ANS Crude Oil to Value California Crudes," to the Final Interagency Report on the Valuation of Oil Produced from Federal Leases in California. At the time of the public release of the Report on May 16, 1996, Appendix 4 was withheld -- allegedly because the information was proprietary to the oil companies, and these companies had refused to allow public access to them.31
The Appendix 4 released to POGO was attached to an October 18, 1996 note from the DOI official handling our FOIA request. The note stated that, in fact, "The companies did not object to release of the Appendix 4 so long as the information was not able to be identified to the companies." 32
Why then did DOI withhold Appendix 4 from public release? This document is a compilation of information from sealed court documents in California. Members of the Interagency Task Force were cleared to review these documents after signing confidentiality agreements. The resulting Appendix 4 demonstrates how the oil companies, for many years, have valued California crude in relation to Alaska North Slope (ANS) crude. It clearly indicates that California crudes were underpriced in relation to ANS -- even after adjustments for quality and transportation.
It also appears that posted prices had only two real purposes: 1. to purchase crude from independent producers at below market prices; and 2. to calculate royalties to be paid to landowners, including the State and federal governments on an artificially low basis. Among themselves, the companies knew the real value of California crude.
According to this Appendix, the oil companies were very well aware of the difference between the two prices, and realized higher profit margins by relying on posted prices rather than using the Alaskan North Slope market price. Appendix 4 states:
The records discussed below show California refiners generally preferred purchases or exchanges of California crude oil because, at prevailing posted prices, profit margins were much higher than for the ANS alternative.
Therefore, the documents exhibit the extent to which the California oil pricing system, i.e., refiners' posted prices, undervalued California crudes' values to the refiners. Since these refiners also produced California Federal crude, and to the extent they paid royalty on posted prices, the royalties they paid did not reflect the value of the crude oil to the company. In most cases, its real value is never seen in the contract transactions because the crude is either transferred to the refining arm of the company, or it is exchanged with another refiner for replacement crude oil. [emphasis added]33
The public release of this information is particularly significant. First, it discredits DOI's earlier assertions that there was no evidence the oil companies used any other valuation measure than posted prices.
Secondly, the public release of Appendix 4 makes it more difficult for the oil industry to claim that posted prices did, in fact, reflect the value of the crude oil. This argument is likely to be the oil industry's defense against a recently proposed clarification of the Federal Rules under which industry must pay royalties in the future. Appendix 4 offers evidence that the new Rule is only asking industry to pay royalties on the value these oil companies themselves rely on.
The last sentence in the above quote from Appendix 4 also indicates the futility of DOI's current efforts to uncover evidence of underpayment through contract-by-contract audits. Unfortunately, in MMS's continuing efforts not to find and collect the unpaid royalties, it is pursuing this method of audit for all post-1988 contracts. A more rational and successful approach would be simply to compare the posted prices to the ANS spot prices at the time, and calculate the difference. MMS, however, is using a contorted reading of the regulations to claim they cannot do this.
During the Reagan Administration, the Linowes Commission was assembled to investigate precisely these same types of failures in DOI's royalty collection process from the 1960's through the early 1980's. Even at that time, the Commission investigated and uncovered failures in Interior's royalty collection process. The summary of the Commission report concludes:
The Federal government must be held accountable for fulfilling a public trust, that is, assuring that royalties for the Nation's energy resources are fully and fairly collected on behalf of the people of the United States.
The Federal government has not fulfilled this trust in the past 20 years.34
Sadly, as this POGO report makes clear, the Federal government continues to fail the public trust in its royalty collection program.
The Department of the Interior has not willingly begun to collect unpaid royalties, and is still not billing for all the money owed to it. In fact, DOI has made a public spectacle of its foot-dragging -- a message that is not being lost on the oil industry.
- In order to be successful in collecting this money, and not simply pursue a paper-pushing exercise, the collection effort must be removed from MMS's hands, and an aggressive team must take it over. POGO is calling for the creation of a new Task Force or "Tiger Team" with the mandate of collecting the unpaid billions of dollars in royalties owed to the public. This body should not come from MMS, and should not study this issue any further. Their job would simply be to tackle the finite project of collecting all of this past due money.
Recommendations from a 1976-77 task force led by then-SEC Director of Enforcement Stanley Sporkin could be a model for this effort. This task force recommended creating a special office in the Department of Energy. This office successfully collected several billion dollars from oil companies for pricing violations.
- In order to ensure that oil producers do not continue to rip-off the public in the future, Representative Maloney has introduced two important pieces of legislation which should be passed in this Congress:
HR 1106, "The Royalty Settlement Reform Act of 1997," which makes the Secretary accountable for any royalty settlement over $2,000,000; and
- HR 1107, "The Royalty Collection Reform Act of 1997," which moves the royalty management program from the Minerals Management Service of DOI to the Financial Management Service of the Department of Treasury.
- Finally, the MMS has undergone a lengthy process in order to clarify the federal Rule under which royalties are paid. The proposed new language will base royalty payments on the NYMEX spot prices as the primary benchmark. The problem calls for exactly this type of reform. POGO supports MMS's efforts in this direction.
In October 1994, when asked why DOI did not correct this situation, Asst. Secretary Bob Armstrong responded, "Sometimes its hard to turn the ship around, when its been going for a long period of time."35 How long do we have to wait? There are those who may believe that criticizing an agency that has begun to change its course is unfair. However, the documents included in this POGO report show that even after repeated exposure of DOI's subservience to the oil industry, DOI still has not acted adequately to protect the public interest.
It was, in large part, because of the pressure caused by the public disclosure of internal documents that DOI made any changes at all -- and we still have a long way to go. As a result, POGO believes it is necessary to continue to maintain pressure on the Department of the Interior by publicly releasing as much information as possible. Permanent policy changes that correct past wrongs and prevent future handouts to the oil industry will not be enacted without continued scrutiny and public pressure.
Therefore, POGO will continue to shed light on this situation until it has been remedied.
1. "Department Of Interior Looks the Other Way: The Government's Slick Deal for the Oil Industry," April 1995; "With a Wink and a Nod: How the Oil Industry and the Department of Interior Are Cheating the American Public and California School Children," March 1996; "Wait! There's More to Collect. . . Unpaid Oil Royalties Across the Nation," August 1996.
2. The majority of the oil companies are currently appealing the bills.
3. See "Wait! There's More to Collect . . ." for POGO's analysis.
4. MMS News Release,"MMS Pursues California Undervaluation Royalties", July 18, 1996.
5. "California Crude Oil Pricing Summary — Additional Royalty Due," September 1983 - February 1988.
6. It is interesting to note that a common thread runs through the resumes of several of the DOI officials involved in this process -- the law firm of Steptoe and Johnson. Secretary Bruce Babbitt, his Chief of Staff Tom Collier, MMS Director Cynthia Quarterman, and Inspector General Wilma Lewis all formerly worked at Steptoe and Johnson, and Tom Collier has returned to his partnership there. Steptoe and Johnson's web page boasts of having extensive legal experience in oil pipelines.
10. Unsigned internal DOI telephone log, "Secure information — California Royalty Secret Deals", March 4 - 24, 1994.
11. Internal DOI memo from Robert A. Berman to Brooks B. Yeager, "Relations with California State Land Commission", March 18, 1994.
12. Unsigned handwritten notes,"re: Cal. Royalty [Under]payment", March 18, 1994, censored version.
16. See "With a Wink and a Nod" Appendix C.
18. MMS press release, July 18, 1996, and "California Crude Oil Pricing Summary."
19. "MMS Global Royalty Settlement Concerns," October 7, 1994.
20. Draft internal DOI memorandum, from Bob Berman to Brooks Yeager, "Global Royalty Settlement Oversights", December 5, 1994.
21. DOI Inspector General "Audit Report on Negotiated Royalty Settlements, Minerals Management Service", September 30, 1996.
22. Letter from Assistant Secretary Bob Armstrong to Representative Carolyn Maloney, February 6, 1997.
23. Letter from Representative Carolyn Maloney to Assistant Secretary Bob Armstrong, March 12, 1997.
24. Unsigned internal memo, "Mobil Settlement Concerns", September 17-18, (1995?).
26. Inspector General Report, September 30, 1996.
29. Department of Energy Memorandum from Robert A. Speir to Dave Hubbard (MMS), "Unpaid Royalty Collection Option Paper", November 30, 1995.
31. Final Interagency Report on the Valuation of Oil Produced from Federal Leases in California Appendix 4 "Companies' Use of ANS Crude Oil to Value California Crudes", undated.
32. Handwritten note for record by Greg Kahn, October 18, 1996.
34. "Report of the Commission: Fiscal Accountability of the Nation's Energy Resources", David Linowes, Chairman, January 1982.