Bad Watchdog Season 2 launches June 20.

Holding the Government Accountable
|
Analysis

Report: Interior Gives Oil Companies Discounts on Drilling Rights

(Illustration: Leslie Garvey/POGO)

When auctioning offshore drilling rights to oil and gas companies, the Interior Department is supposed to reject bids that are lower than its own estimates of what the drilling rights are worth.

Instead, when bids come in lower than Interior’s valuations, Interior often lowers its valuations and then accepts the bids on the basis of the altered valuations, a new study by a federal watchdog found.

The report paints a picture of the Interior Department bending over backwards to award drilling rights to energy companies.

The Interior Department “could be forgoing hundreds of millions of dollars” in auction revenue “by accepting bids that are too low,” the study found.

The report by the Government Accountability Office (GAO), an investigative arm of Congress, paints a picture of the Interior Department bending over backwards to award drilling rights to energy companies.

The Project On Government Oversight (POGO) spotlighted some of that conduct in a 2018 investigative report.

“In simplest terms, if bids don’t clear the bar, the government can lower the bar,” POGO reported.

The Interior Department’s Bureau of Ocean Energy Management (BOEM) manages drilling rights on behalf of the American public. The bureau periodically holds auctions in which successful bidders obtain leases on tracts of the sea floor and rights to the underlying oil and gas deposits. The bureau is required by law to ensure that taxpayers receive “fair market value.”

Bureau officials told the GAO that they deliberately take a conservative approach to estimating how much tracts are worth, the report said. According to the GAO, bureau officials said the objective of the tract valuation process “is to lease tracts and collect associated revenues except when BOEM determines a tract is worth significantly more than the highest bid received.”

However, according to the GAO report, which was published on September 25 and released on October 24, the bureau has been going to great lengths to accept bids. The GAO described two ways the bureau may be shortchanging the public.

First, the bureau lowers many valuations to accept bids that would be unacceptable under the bureau’s stated procedures, the GAO said.

“BOEM officials told us that when bids are slightly below the bureau’s initial valuations—and therefore would be rejected per BOEM’s procedures for ensuring receipt of fair market value—BOEM reviews and adjusts its forecasting parameters then reruns its model in order to produce new valuations,” the GAO said.

The Bureau of Ocean Energy Management lowers many valuations from its model to justify accepting bids it otherwise would reject.

GAO report "OFFSHORE OIL AND GAS: Opportunities Exist to Better Ensure a Fair Return on Federal Resources"

The bureau “lowers many valuations from its model to justify accepting bids it otherwise would reject,” the GAO said.

Though bureau officials said BOEM made such adjustments where bids fell slightly short of its original valuations, the study found that the bureau used do-overs to overcome wide gaps. The practice “is nearly systematic” in cases where the bureau originally estimated that tracts were worth up to twice as much as the amount bid, the GAO said.

The bureau does not disclose when it has awarded drilling rights on the basis of reduced valuations, and revising valuations is not part of the bureau’s published procedures, Frank Rusco, the lead author of the GAO report and head of the GAO’s research on energy issues, said in an interview with POGO.

The GAO studied bids and bid assessments going back to the Clinton administration—from March 2000 through June 2018. If the bureau took a more reasonable approach over that period, it could have collected $567 million of additional auction revenue, the GAO report said.

The GAO also criticized another bureau practice—a variation on the theme that makes the bureau’s initial valuations artificially low, thereby enabling it to accept unreasonably low bids without resorting to the more blatant do-overs.

When assessing the value of an offshore tract, the bureau’s stated procedures say it can consider two different measures: the present value and the delayed value. The present value is supposed to reflect the value at the time of the auction. The delayed value is supposed to show what the tract would be worth if the bureau rejected the bid and offered it at the next auction. The point is to consider the cost, if any, of delaying the award of drilling rights. Under the bureau’s published procedures, if the bid is lower than the present value but higher than the delayed value, the bureau can accept it.

The lower of the present value or the delayed value becomes the bureau’s initial valuation.

However, the GAO found that the bureau has unreasonably depressed delayed values.

Given the “very short” intervals between auctions, the anticipated loss of value seems unreasonably large, the GAO said. What’s more, the bureau’s predicted cost of delay has been growing when it should have been shrinking, the GAO found.

Until August 2017, when the bureau was holding annual auctions, it typically forecast that tracts would lose almost a quarter of their value, 23%, by the next auction. Since then, as the bureau has shortened the interval between auctions by about half, the predicted decline in value has grown to an average of about 27%, or an annual rate of about 47%, the GAO said.

In addition, because oil prices are generally forecast to rise, the values of the oil and gas deposits “would be expected to increase over time rather than decrease,” the report said.

Consistent with that theory, when the bureau has rejected bids, it has generally received higher bids for the same tracts in later auctions, the GAO said. On average, the tracts later sold for more than twice the amount the bureau initially rejected, the GAO said.

One reason a tract could lose value over time is that the underlying oil reservoir is being tapped and drained from a nearby tract. But the GAO found that the tracts involved were not so-called drainage tracts and that, based on bureau records, drainage was not a factor, the GAO’s Rusco told POGO.

The bureau’s unreasonably large forecasts of depreciation have increasingly been the deciding factor in decisions to accept bids.

GAO report "OFFSHORE OIL AND GAS: Opportunities Exist to Better Ensure a Fair Return on Federal Resources"

The GAO wrote that the bureau “has not provided any reasonable explanations for its high levels of forecasted depreciation,” meaning the loss of value attributed to delay.

What’s more, the GAO found that the bureau’s “unreasonably large forecasts of depreciation have increasingly been the deciding factor in decisions to accept bids.”

Had the bureau rejected 205 bids that it accepted on the basis of delayed values, “it might have subsequently collected more than $873 million in additional bid revenue for these tracts,” the GAO said.

(Apart from its valuations of specific tracts, the bureau sets a uniform floor on bids—for example, $100 per acre in water depths of 400 meters or more. The tract-specific valuations apply once bids have exceeded those standard minimums and once the bureau has determined that the tracts are economically “viable”—in other words, that an energy company could extract oil or gas from them at a profit.)

The GAO report said the bureau's valuation process "might not fully assure receipt of fair market value."  Compared to the findings the GAO laid out in the report, that wording appeared to be an exercise of characteristic restraint.

The GAO’s analysis of delayed values tracks findings in POGO’s 2018 report, Drilling Down: Big Oil's Bidding. Here’s an excerpt from POGO’s report:

The government’s use of that alternative measure can result in head-scratching outcomes.

When the Bureau considered bids placed in the August 2017 auction, it determined that the [present value] for one tract was $17 million and that the delayed value of the tract was $6.9 million. In other words, BOEM estimated that, over several months, an unusually valuable tract would lose more than half its value. On that basis, BOEM accepted a bid of $12.1 million, much less than it said the drilling rights were worth at that time.

Given that oil prices can rise or fall unpredictably over time, it isn’t obvious that delaying the sale of drilling rights would reduce their value. In fact, by the government’s own account, rejecting bids and offering the tracts again later “has consistently resulted in higher average returns in subsequent lease sales for the same tracts, even when those tracts not receiving subsequent bids were included in the calculation of the average returns.”

In the Gulf of Mexico from 1984 through 2017, BOEM has stated, the Bureau “rejected total high bids of $638 million, but when the blocks were reoffered, they drew subsequent high bids of $1.8 billion, for a total net gain of $1.2 billion, or an increase of 187 percent.”

The Interior Department has been engaged in “a virtual giveaway of offshore drilling rights,” POGO reported.

Bureau spokespeople did not respond to an inquiry for this story.

In a written response to the GAO, Interior’s Acting Assistant Secretary for Land and Minerals Management Casey Hammond said the bureau “does not concur with how its bid valuation process is characterized in GAO’s report.” The bureau rejected GAO’s recommendation that it enlist “an independent third party” to examine whether the use of delayed valuations is delivering fair market value and whether those valuations should be ended.

The bureau nonetheless agreed with a GAO recommendation “to review its bid valuation process to reduce any bias that may exist,” Hammond wrote.

“BOEM will develop a plan to perform a comprehensive internal review of the delayed value calculations and make appropriate changes,” Hammond wrote.