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Project on Government Oversight

Testimony of POGO's Danielle Brian before the Department of Interior Minerals Management Service's Public Hearing Regarding the Proposed Oil Valuation Rule

Related Content: Oil & Gas Royalty Revenue
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February 1, 1998 | By: Danielle Brian

I am Danielle Brian, Executive Director of the Project On Government Oversight. We are a non-profit, non-partisan government watchdog group which, for the past four years, has been investigating, exposing and remedying the oil industry's underpayment of royalties to the federal government.

I commend the Department of Interior's Minerals Management Service's (MMS) efforts to clarify the royalty valuation language in the Final Proposed Rule. We have come a long way. This Rule is a giant step for the taxpayer as it will largely prevent future underpayments of royalties.

I recognize the time and thought MMS has invested in this important effort. This complicated issue is not easy, and I imagine it is a formidable task to protect the interests of the American public from the considerable leverage presented by the oil industry.

The general move to a market-based valuation method, particularly in the larger federal oil-producing areas, is clearly the appropriate and necessary resolution to this dilemma. All independent assessments have shown that this will be a revenue-positive step, as industry will finally be required to pay royalties on the value that they receive for the oil.

Having said that, I would like to make two recommendations regarding the Proposed Rule. I believe both of these issues are significant enough that they have the potential to seriously undermine MMS's intent.

The first is that the new language places greater reliance on the gross proceeds standard in the case of exchanges than any of the previous drafts of the Rule. The current language would require MMS to trace the value of the federal oil downstream after multiple exchanges -- possibly sending us back to the days of the daisy-chain schemes where the oil industry was regularly hiding the value of oil downstream. A simple fix to this problem would be to limit the number of transactions MMS auditors would be required to track to a maximum of one or two exchanges, after which point the company would be required to pay royalties based on index pricing, as was proposed in earlier drafts of the Rule.

Secondly, the new Proposed Rule understates the prevalence of balancing agreements, and places the burden on MMS to discover them. Experience has taught us how difficult, if not impossible, these agreements are for auditors to detect. MMS should reinstate language in the Final Rule that would specifically require companies to disclose their over-all balancing agreements (subject to audit) shifting the burden from MMS back to the companies.

The final point is that the current language places no limits on the transportation allowances companies can deduct -- creating a situation where total transportation could be deducted even if the oil is moved far downstream from where the spot price has been quoted. MMS should limit the transportation allowances to the cost of moving the oil from the wellhead to the closest market, unless the company can show a hardship that requires them to transport the oil farther.

I would also like to take this opportunity to point out that the implementation of this Rule, particularly with the above recommended modifications, resolves the problem that brought us all together in the first place. This Rule will address the underpayment of royalties to the federal government. As a result, there is no reason to consider industry's suggestion for a nationwide mandatory royalty-in-kind program. In fact, I believe it is patently obvious that industry's RIK plan is merely a diversionary tactic intended to derail this Rulemaking.

As you know, last week the U.S. Department of Justice concluded that there is sufficient concern about this industry's past practices regarding the payment of federal royalties that they have intervened in a fraud case on the subject. I submit that this ongoing investigation should cause policy-makers to take a good hard look at any criticisms of this Proposed Final Rule emanating from industry, and recognize that these clarifications to royalty valuation regulations have been made necessary because of industry's history of unwillingness to pay what they owe.

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