Holding the Government Accountable

POGO Calls for Congressional Action to Reform Onshore and Offshore Royalty Systems

(Illustration: Leslie Garvey/POGO)

Chair Pingree, Ranking Member Joyce, and Members of the Subcommittee, thank you for the opportunity to submit testimony on the need to increase royalty rates and overall accountability and transparency for oil and gas royalty policy at the Department of the Interior. POGO is a nonpartisan independent watchdog that investigates and exposes waste, corruption, abuse of power, and when the government fails to serve the public or silences those who report wrongdoing. We champion reforms to achieve a more effective, ethical, and accountable federal government that safeguards constitutional principles.

For decades, POGO has shed light on the need for the federal government to ensure the oil and natural gas industries are paying their fair share for the publicly owned resources they extract and profit from.1 That is why we support Representatives Katie Porter’s (D-CA) and Raúl Grijalva’s (D-AZ) Ending Taxpayer Welfare for Oil and Gas Companies Act(H.R. 1517), which would modernize the onshore leasing system for the first time in a century by increasing royalty rates on publicly owned onshore leases. Congressional action is also needed for offshore reform.

Onshore Royalties

As Congress looks for ways to finance priorities such as the upcoming infrastructure and climate package, I strongly encourage the subcommittee to examine increasing the royalties the federal government collects for resources the extractive industry collects from public lands.

Royalties from onshore and offshore energy and minerals extracted on federal land provide a significant revenue stream to the federal government. In fiscal year 2020, the federal government received almost $7.6 billion, and more than $12 billion in fiscal year 2019.2 These royalties go to the federal treasury as well as to state and local governments, and some states depend on that revenue to fund key programs, such as education.3

Congress last set the minimum royalty rate for onshore oil and gas leases at 12.5% in 1920, and federal agencies have not raised it since.

Congress last set the minimum royalty rate for onshore oil and gas leases at 12.5% in 1920, and federal agencies have not raised it since.4 Representatives Porter’s and Grijalva’s bill would correct this problem by increasing the federal onshore royalty rate to 18.75%.

I recommend that this subcommittee fund an Interior Department study to examine the options for increasing federal royalties for oil and natural gas on federal lands. In 2016, the Congressional Budget Office found that increasing the onshore royalty rate from 12.5% to 18.75% could increase revenue to the federal government by as much as $200 million over 10 years with little or no impact on production levels.5 New findings from the Interior Department could help better inform this subcommittee and Congress as a whole as to what modernizing our nation’s onshore leasing system could mean for taxpayers and state and federal revenue streams.

In addition, I encourage the subcommittee to direct the Interior Department to study the effects of implementing a royalty for hard-rock minerals. Under the General Mining Law of 1872, taxpayers receive zero royalties for locatable minerals on public lands in the western U.S.6 The U.S. lags behind the rest of the world by failing to collect royalties for these minerals.7

Royalty Relief and Billions in Forgone Royalties

Together, offshore drilling and the leasing of publicly owned tracts of seafloor brought in nearly $90 billion in federal revenue between 2006 and 2018.8 The Interior Department’s Bureau of Ocean Energy Management (BOEM) sets royalty rates for offshore oil and gas based on market conditions and is legally required to ensure that taxpayers receive “fair market value” for the resources extracted by private industry.9 The bureau also has several options to reduce or waive royalty payments to increase production. But the bureau’s so-called “royalty relief” procedures often result in forgone royalty payments worth tens of billions of dollars. As the bureau itself has found, its practices often mean taxpayers lose out on the fair return they’re owed.10

For example, from 1996 to 2000, the Interior Department leased tracts with a guarantee that it would not collect royalties on the initial volume of oil or gas produced. As a result, the Government Accountability Office (GAO) found in a 2019 report, the leases awarded with those terms resulted in about $18 billion in forgone royalties through 2018.11

The GAO also identified two additional procedures the Interior Department has engaged in for decades that may not have resulted in a full fair market value return for oil and gas leases: retroactively lowering its valuations of tracts of seafloor in order to accept bids that would be unacceptable under the bureau’s stated procedures; and accepting lower bids because it unreasonably determined the tracts might be worth less in the future.12

Lowered Tract Valuations Behind Closed Doors

When auctioning off tracts of seafloor, the bureau is supposed to reject bids that are lower than its own estimated value of the tracts’ worth. Instead, the GAO found, when a bid comes in lower than the bureau’s own valuation, rather than rejecting the bid, the bureau often lowers its initial valuation “to justify accepting bids it otherwise would reject,” and then accepts the lower bid.13

Taxpayers receive zero royalties for locatable minerals on public lands throughout the West and Intermountain West.

This would be rational if the government thought that rejecting bids would result in tracts not being sold, leading to forgone revenue. But in fact, when the bureau rejected bids that were too low, industry would often submit higher bids for the same tracts in subsequent auctions, resulting in higher bid revenue for the government.14 As the GAO noted, by resubmitting bids at higher amounts, companies signaled that they viewed certain tracts as more valuable than their initial bids had indicated.

The GAO found the bureau’s practice of lowering its valuations “is nearly systematic” in cases where it had originally estimated that tracts were worth up to twice as much as the amount bid.15 The GAO estimated that from March 2000 to June 2018, the bureau could have collected $567 million in additional auction revenue if it had not lowered its valuations.16 This doesn’t give the taxpayer a fair return as the law requires.

As POGO has previously noted, the bureau does not disclose when it awards drilling rights based on reduced valuations, and revising valuations is not part of the bureau’s published procedures.17

Because the practice of lowering valuations has resulted in the loss of hundreds of millions of dollars in public revenue, this subcommittee has a vested interest in ensuring that the bureau makes public its revised valuations. This subcommittee should prohibit the use of funds to approve leases where the bureau retroactively lowered its valuations without public notice.18

Forecasts of “Unreasonably” High Depreciation

The GAO’s 2019 report also highlighted problems with how the bureau considers two key measures of the worth of a tract of seafloor: the present value and the delayed value. The GAO found the bureau’s broad calculations and use of delayed valuation may have resulted in more than $873 million in forgone additional bid revenue from March 2000 to June 2018.19

The present value is supposed to reflect the tract’s value at the time of the auction, and the delayed value should show what it would be worth if it were offered at the next auction. Calculating the delayed value is meant to help the bureau determine the cost of delaying the auction of a lease. If a bid is lower than the present value but higher than the delayed value, the bureau can accept it. But, the GAO found, the bureau has been projecting delayed values to be lower than they should be, leading the bureau to accept lower bids.

Until August 2017, the bureau held auctions once a year and typically forecasted a median loss of 23% of value by the next auction. Although the bureau has since held auctions about every six months, its predicted decline in value has grown to a median of about 27%.20 Because the frequency of auctions doubled, it’s surprising that the bureau’s predicated cost of delay increased. As the GAO noted, with oil prices generally forecasted to rise, the value of oil and gas resources would be expected to increase over time, so the cost of delaying should decrease.

The GAO found that the bureau’s “unreasonably large forecasts of depreciation have increasingly been the deciding factor in decisions to accept bids.” By lowering a tract’s predicted future value, the government is needlessly passing up hundreds of millions of dollars in revenue.

The Interior Department did not concur with how GAO characterized its bid valuation process. Nor did it agree with GAO’s recommendation of having “an independent third party” examine whether its use of delayed valuations delivers fair market value and whether it should stop using those lower valuations.21 POGO believes such an independent examination would bring greater accountability to the bid valuation process, and recommends that this subcommittee bar funds from being used to approve a delayed-value lease that was not evaluated by a third party.

Conclusion and Recommendations

POGO recommends that the subcommittee direct the Interior Department to study the effects of raising the federal onshore oil and gas royalty rate on production and revenue. This resultant report should also examine the effects of imposing a royalty for hard-rock mining in the West.

POGO has prepared language to provide more accountability and transparency for offshore oil and gas royalty policy, which we are happy to provide. The language requires the Bureau of Ocean Energy Management to disclose accepted bids when it retroactively lowers the initial valuation, and requires that a third party examine the bureau’s delayed valuation system.