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Project on Government Oversight

Written Testimony of Danielle Brian, Royalty-in-Kind Provisions of the Energy Bill

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July 10, 2001 | By: Danielle Brian

Industry has claimed that royalty-in-kind programs will end disputes over the fees they owe for drilling oil and gas from federal and Indian lands. Under royalty-in-kind, companies pay in barrels of oil (or units of gas) rather than in dollars. The Department of Interior has completed two pilot programs to date in order the test whether royalty-in-kind programs will work.

The two programs have failed, losing significant revenues in comparison to dollars received from programs that collect cash. According to the Department of Interior's Inspector General, the first pilot program to collect gas royalties-in-kind lost 6.5%. Earlier this year a second pilot program to collect oil royalties-in-kind lost $3 million.

In 1998, the General Accounting Office analyzed the prospect of royalty-in-kind and determined that there were significant barriers to ensuring that the federal government receives its fair share: "According to information from studies and the programs themselves, royalty-in-kind programs seem to be feasible if certain conditions are present...However, these conditions do not exist for the federal government or for most federal leases..." (Federal Oil Valuation: Efforts to Revise Regulations and an Analysis of Royalties in Kind GAO/RCED-98-242).

Section 232 "Program on Oil and Gas Royalties in Kind" of the House Resources Committee energy bill proposes giving the Secretary of Interior authority to further expand collections of royalties-in-kind. The two pilot programs failed despite the fact that the Interior Department selected oil and gas leases most likely to succeed in generating comparable income. Expansion of royalty-in-kind programs to leases less likely to succeed will only lead to additional revenue losses for the American people. Section 232 would institutionalize the further loss of millions of taxpayer dollars to major oil and gas companies.

There is also no evidence that royalty-in-kind will end litigation or disputes over how much oil and gas companies should be paying. Litigation over oil royalty underpayments resulted in recent settlements with the Justice Department for $425 million. Now, several lawsuits filed by industry whistleblowers allege that companies undermeasured the volume of the oil and gas taken from public lands in order to avoid paying royalties. Because companies pay in barrels of oil or units of gas under royalty-in-kind, underpayments may already be slipping through the system. These allegations call into question the wisdom of accepting any payments in kind until the allegations are fully investigated. The Interior Department has historically failed to detect these kinds of underpayments which have only been brought forward by whistleblowers.

Finally, if the provisions are kept in the bill, several language revisions will close gaping loopholes in Section "(d) Benefit to the United States Required." This section states "The Secretary may receive oil or gas royalties in kind only if the Secretary determines that receiving such royalties provides benefits to the United States greater than or equal to those that would be realized under a comparable royalty in value program." This language is vague and does not do enough to protect the taxpayer's interests, particularly given the Interior Department's lackluster performance to date. This section should be revised as follows: "The Secretary may receive oil or gas royalties in kind only if the Secretary has analyzed and documented the expected return in advance of any royalty-in-kind sales to assure to the maximum extent practicable that royalty income under the pilot program is equal to or greater than market prices."

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