(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, April 10 Collection of royalty payments
from production of oil and gas on federal lands is one of the
government programmes most at risk from fraud, waste and
mismanagement, according to congressional investigators.
"The Department of Interior does not have reasonable
assurance that it is collecting its share of revenue from oil
and gas produced on federal lands, and continues to experience
problems in hiring, training and retaining sufficient staff to
provide oversight," according to the Government Accountability
Office (GAO) in a report sent to Congress.
Royalty collection is one of just 30 functions from across
the federal government on the 2013 High Risk List compiled by
GAO, headed by the comptroller and auditor-general, and often
called the "congressional watchdog" for its role in highlighting
waste, fraud and inefficiency in federal agencies and
Other programmes named and shamed on this year's list
include contract management at the Defense Department,
protecting federal government computers from cyber attacks, and
restructuring the troubled finances of the U.S. Postal Service
GAO has published the list every two years since 1990 to
coincide with the start of each new Congress, with the aim of
focusing policymakers' attention on programmes the agency judges
present an especially great danger of waste and fraud, or most
in need of transformation.
Just 55 programmes have appeared on the list since 1990, and
23 have been removed after problems were rectified. Typically it
takes 5-15 years for the government to make sufficient progress
to convince GAO to remove a programme (though Defense Department
and NASA procurement, as well as Medicare and tax enforcement
are hardy perennials and have remained on the list since the
Normally, GAO puts programmes on the list if amounts of at
least $1 billion are considered at risk.
Management of federal oil and gas resources first hit the
red list in 2011, following the Deepwater Horizon disaster and
persistent concerns about the verification of production and
collection of royalties by the Minerals Management Service (MMS)
(offshore) and Bureau of Land Management (BLM) (onshore).
The MMS has since been reorganised into three separate
separate functional agencies: the Bureau of Ocean Energy
Management (BOEM) (responsible for leasing), the Bureau of
Safety and Environmental Enforcement (BSEE), and the Office of
Natural Resources Revenue (ONRR).
But congressional investigators remain deeply concerned
about high-levels of staff turnover, inadequate production
audits and lack of assurance that the proper royalties are being
THE GOVERNMENT'S DIME
The federal government collected $10 billion in both fiscal
2010 and fiscal 2011 in oil and gas royalties. It receives money
from more than 28,000 leases, and petroleum royalties are one of
the largest sources of non-tax revenue.
Under lease terms, producers must submit monthly reports
specifying their output (and its division between oil and gas)
as well as royalties due. The government conducts detailed
audits and more routine compliance reviews to check the accuracy
and reasonableness of the data.
In addition, BLM and BOEM inspectors conduct onsite checks
(typically reading oil and gas meters and verifying their
calibration) and review production records.
But in 2008, GAO warned data management problems and
reliance on self-reported data were putting revenue collection
Interior Department agencies were not conducting the annual
checks on all leases producing "significant" amounts of oil and
gas required by law, according to GAO, in part because they
could not cope with the increased amount of drilling and because
staff were still dealing with clean up following hurricanes
Katrina and Rita.
"Officials ... told us that some inspection and data-entry
staff are relatively inexperienced and do not always record the
inspections in their databases as procedures require," GAO
wrote. In many instances, GAO found agencies relied on
self-reported or third-party documents to see if production data
looked "reasonable" without carrying out detailed verification
to ensure they are accurate.
In Colorado, Montana, New Mexico, Utah and Wyoming, which
have more than 95,000 wells on federal lands, only 8 of 24 BLM
field offices had carried out all the annual checks required on
high-producing leases or those which have a history of reporting
violations, according to the 2008 report. Offshore inspectors
met targets just once between 2004 and 2008. Onshore inspectors
achieved their targets only about a third of the time over a 12
In 2010, GAO warned the "Department of Interior's oil and
gas production verification efforts do not provide reasonable
assurance of accurate measurement of production volumes." GAO
made 19 detailed recommendations for improvement, of which the
Interior Department accepted 16 and partially agreed with the
remaining 3. But so far just 5 have been implemented.
Interior agencies are struggling to hire and retain skilled
geophysicists, geologists and petroleum engineers. Low pay
compared with the private sector and the high cost of living in
energy boom towns have all contributed to turnover problems.
In 2012 and 2013, Congress provided extra money to raise
minimum pay rates for offshore inspectors in the Gulf of Mexico
by up to 25 percent for key positions. But hiring remains
difficult. There is no long term funding for higher salaries.
Nothing similar has been done to authorise or fund higher pay
for onshore inspectors.
It is impossible to measure oil and gas production with 100
percent accuracy; both producers and regulators rely on a
variety of estimating and metering techniques to produce
The important thing is that estimates should be free from
bias and should not consistently over-estimate or under-estimate
production. Given that royalties are assessed on the marketed
value of production, it is vital for regulators to check the
natural tendency to under-report volumes.
It is also vital that the quantities of dry natural gas
(methane) and natural gas liquids (ethane, propane, butane and
natural gasoline) are correctly recorded. Liquids have a much
higher value so royalties owed on them are significantly higher.
With the growing output of natural gas liquids from wet gas
plays, and the six-fold gap between gas and oil prices (on an
energy content basis), it is more important than ever to measure
liquids production accurately.
However, GAO found significant inconsistencies in the way
the different Interior agencies measure oil and gas production
offshore and onshore, as well as between different field offices
of the same agency. The agencies have struggled to get access to
meter readings on dry gas and liquids from natural gas
There have been inconsistent approaches to approving
requests from commingling. Production from several different
leases may be combined for metering purposes, measured on a
unified basis, then allocated back to the individual leases.
Commingling can cut down on metering and is often advantageous
for producers and may be encouraged by regulators, but it also
makes accurate measurements much harder.
GAO has also found agencies confused about their respective
roles. In 2009, BLM admitted it had not inspected meters or
checked volumes at natural gas plants because it assumed this
was the responsibility of MMS, which was not checking either.
"When we discussed gas plants with BLM staff at field
offices, some petroleum engineer technicians did express some
concern about the accuracy of royalty payments based on how
products were both handled and measured downstream beyond the
BLM's point of measurement," GAO wrote in 2010. "However, most
BLM staff were not concerned because they considered anything
past their point of measurement beyond their jurisdiction."
BLM staff have been so busy supervising drilling of new
wells, and coping with hiring and retaining inspectors, they
have insufficient time to complete all the inspections required
by law. An official at one field office told GAO in 2010 it was
"de facto" policy not to complete production inspections. The
number of meter readings and tank-gauging operations witnessed
by BLM inspectors has been falling for the last decade.
The Interior Department is working with GAO to address the
shortcoming identified in 2008 and 2010. A progress review is
currently underway. But the GAO is still waiting to be
convinced. Accurate production reporting and royalty collection
therefore remains at the top of the federal auditor's concerns
and high on the congressional radar.