SPEAKERS CONTENTS INSERTS
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45–026 CC
1997
OVERSIGHT HEARINGS ON ROYALTY-IN-KIND FOR FEDERAL OIL AND GAS PRODUCTION
OVERSIGHT HEARINGS
before the
SUBCOMMITTEE ON ENERGY
AND MINERAL RESOURCES
of the
COMMITTEE ON RESOURCES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
FIRST SESSION
JULY 31 AND SEPTEMBER 18, 1997, WASHINGTON, DC
Serial No. 105–41
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Printed for the use of the Committee on Resources
COMMITTEE ON RESOURCES
DON YOUNG, Alaska, Chairman
W.J. (BILLY) TAUZIN, Louisiana
JAMES V. HANSEN, Utah
JIM SAXTON, New Jersey
ELTON GALLEGLY, California
JOHN J. DUNCAN, Jr., Tennessee
JOEL HEFLEY, Colorado
JOHN T. DOOLITTLE, California
WAYNE T. GILCHREST, Maryland
KEN CALVERT, California
RICHARD W. POMBO, California
BARBARA CUBIN, Wyoming
HELEN CHENOWETH, Idaho
LINDA SMITH, Washington
GEORGE P. RADANOVICH, California
WALTER B. JONES, Jr., North Carolina
WILLIAM M. (MAC) THORNBERRY, Texas
JOHN SHADEGG, Arizona
JOHN E. ENSIGN, Nevada
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ROBERT F. SMITH, Oregon
CHRIS CANNON, Utah
KEVIN BRADY, Texas
JOHN PETERSON, Pennsylvania
RICK HILL, Montana
BOB SCHAFFER, Colorado
JIM GIBBONS, Nevada
MICHAEL D. CRAPO, Idaho
GEORGE MILLER, California
EDWARD J. MARKEY, Massachusetts
NICK J. RAHALL II, West Virginia
BRUCE F. VENTO, Minnesota
DALE E. KILDEE, Michigan
PETER A. DeFAZIO, Oregon
ENI F.H. FALEOMAVAEGA, American Samoa
NEIL ABERCROMBIE, Hawaii
SOLOMON P. ORTIZ, Texas
OWEN B. PICKETT, Virginia
FRANK PALLONE, Jr., New Jersey
CALVIN M. DOOLEY, California
CARLOS A. ROMERO-BARCELÓ, Puerto Rico
MAURICE D. HINCHEY, New York
ROBERT A. UNDERWOOD, Guam
SAM FARR, California
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PATRICK J. KENNEDY, Rhode Island
ADAM SMITH, Washington
WILLIAM D. DELAHUNT, Massachusetts
CHRIS JOHN, Louisiana
DONNA CHRISTIAN-GREEN, Virgin Islands
RON KIND, Wisconsin
LLOYD DOGGETT, Texas
LLOYD A. JONES, Chief of Staff
ELIZABETH MEGGINSON, Chief Counsel
CHRISTINE KENNEDY, Chief Clerk/Administrator
JOHN LAWRENCE, Democratic Staff Director
Subcommittee on Energy and Mineral Resources
BARBARA CUBIN, Wyoming, CHAIRMAN
W.J. (BILLY) TAUZIN, Louisiana
JOHN L. DUNCAN, Jr., Tennessee
KEN CALVERT, California
WILLIAM M. (MAC) THORNBERRY, Texas
CHRIS CANNON, Utah
KEVIN BRADY, Texas
JIM GIBBONS, Nevada
CARLOS ROMERO-BARCELÓ, Puerto Rica
NICK J. RAHALL II, West Virginia
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SOLOMON P. ORTIZ, Texas
CALVIN M. DOOLEY, California
CHRIS JOHN, Louisiana
DONNA CHRISTIAN-GREEN, Virgin Islands
——— ———
BILL CONDIT, Professional Staff
SHARLA BICKLEY, Professional Staff
DEBORAH LANZONE, Legislative Staff
C O N T E N T S
Hearings:
July 31, 1997
September 18, 1997
Statements of Members:
Cubin, Hon. Barbara, a Representative in Congress from the State of Wyoming
Prepared statement of, September 18, 1997
Maloney, Hon. Carolyn, a Representative in Congress from the State of New York
Prepared statement of
Romero-Barceló, Hon. Carlos, a Delegate in Congress from the Territory of Puerto Rico,
Prepared statement of, July 31, 1997
Romero-Barceló, Hon. Carlos A., a Delegate in Congress from the Territory of Puerto Rico, July 31, 1997
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Prepared statement of, September 18, 1997
Thornberry, Hon. William M. ''Mac,'' a Representative in Congress from the State of Texas, July 31, 1997
Statements of witnesses:
Brian, Danielle, Executive Director, Project on Government Oversight
Prepared statement of
Brown, Robert E., Associate Director, Minerals Management Service, U.S. Department of the Interior
Prepared statement of
Cohelan, Timothy, Esquire, Cohelan & Koury
Prepared statement of
Darouse, David, Mineral Revenue Regional Auditor Supervisor, Department of Natural Resources, Baton Rouge, Louisiana
Prepared statement of
Hagemeyer, Fred, Coordinating Manager, Royalty Affairs, Marathon Oil Company
Prepared statement of
Hamm, Sue Ann, Vice President, Oil Marketing/Sales, Continental Resources, Incorporated
Prepared statement of
Henderson, William, Market Development Representative, Gulf Canada Resources
Prepared statement of
Magagna, Jim, Director, Office of State Lands and Investments, Office of Federal Land Policy, State of Wyoming
Prepared statement of
Neufeld, Bob, Vice President, Environment & Government Relations, Wyoming Refining Company
Prepared statement of
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Nichols, Larry, President, Devon Energy
Prepared statement of
Quarterman, Cynthia, Director, Minerals Management Service
Prepared statement of
Reid, Spencer, Deputy Land Commissioner, Texas General Land Office
Prepared statement of
Rorschach, Richard, National Chairman, National Association of Royalty Owners
Prepared statement of
Rothschild, Edwin S., Public Affairs Director, Citizen Action
Prepared statement of
Segner, Edmund, III, Executive Vice President and Chief of Staff, Enron Corporation
Prepared statement of
Smith, Linden, Managing Director, Barents Group
Prepared statement of
Additional material supplied:
Briefing paper
Congressional Research Service, Library of Congress, Memorandum from Marc Humphries and Lawrence Kumins
Crude Oil Royalty Payment Analysis, Report to the State Land Offices of Colorado, New Mexico, and Texas
DiBona, Charles, American Petroleum Institute
Petroleum Marketing Act
Questions from Mrs. Cubin and Mr. Romero-Barceló and answers from witnesses
State of Louisiana, prepared statement of, submitted by David Darouse
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OVERSIGHT HEARING ON ROYALTY-IN-KIND FOR FEDERAL OIL AND GAS PRODUCTION
THURSDAY, JULY 31, 1997
House of Representatives, Subcommittee on Energy and Mineral Resources, Committee on Resources, Washington, DC.
The Subcommittee met, pursuant to call, at 2:05 p.m., in room 1334, Longworth House Office Building, Hon. Barbara Cubin [chairman of the Subcommittee] presiding.
STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF WYOMING
Mrs. CUBIN. The Subcommittee on Energy and Mineral Resources will come to order. The Subcommittee is meeting today to hear testimony on royalty-in-kind for Federal oil and gas production. Under Rule 4[g] of the Committee Rules, any oral opening statements at hearings are limited to the Chairman and the Ranking Minority Member.
This will allow us to hear from our witnesses sooner and help members keep to their busy schedules. Therefore, if other members have statements, they can be included in the hearing record under unanimous consent.
The Subcommittee meets today to review issues concerning the collection of production royalties due to the United States from Federal oil and gas leases on shore and on the outer continental shelf. During the last Congress, Chairman Calvert held a hearing to review the initial evaluation by the Minerals Management Service of the pilot program the agency had conducted in the Gulf of Mexico for natural gas royalty-in-kind.
That effort led to inclusion of language in the Appropriations Committee report for the 1997 Interior Department's spending bill urging consideration of further royalty-in-kind initiatives by MMS.
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Many of us in Congress view the idea of a broad based royalty-in-kind program as a way to greatly diminish the enormous costs associated with audit and enforcement functions of collecting royalty-in-value.
For fiscal year 1998, the House has funded the valuation and compliance subactivities within the MMS budget at $68.3 million, but the true costs are still much higher because the Federal Government must expend substantial legal and administrative resources to answer protests, appeals, and litigation which ensue from differing interpretation of the value of oil and gas for royalty purposes.
Lest anyone forget, let me remind you that I represent the State of Wyoming in this body. And my state bears by far the largest portion of any state's cost burden under the so-called net receipts sharing formula which was codified as permanent law in the Omnibus Budget Reconciliation Act of 1993.
And by my quick arithmetic, the State of Wyoming has had over $50 million taken from its half of the Federal mineral lease receipts since the inception of the net receipts sharing methodology in fiscal year 1991.
The cumulative burden upon the states with onshore Federal leases for fiscal year 1997 alone is $22.1 million representing one-fourth of the cost of administering onshore mineral leases by the BLM, the U.S. Forest Service, and the MMS.
Without question, savings in these administrative costs, which may be realized through efficiency gains such as collecting oil and gas royalties-in-kind rather than in-dispute value, will reduce the burden upon the states paying the Federal Government's freight, as well as enrich the U.S. Treasury to the benefit of taxpayers throughout the nation.
To my way of thinking, there simply must be a better way to more efficiently collect what is owed to the United States in return for the right to explore, develop, and produce oil and gas from Federal lands; more efficient for the Feds and, therefore, by way of the net value sharing formula, less burdensome on the states and, yes, more efficient for industry which must put their money and capital at risk in the first place so there would no income to the Federal Government or the states.
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Now, I realize that royalty-in-kind theoretically looks good, but putting it into practice is not necessarily cut and dry. But should we shy away from pursuing the idea because a particular segment of the industry or perhaps a particular state or two has certain problems with this method, I say absolutely not, nor should we in Congress simply take at face value allegation by folks with a vested interest in the status quo that R-I-K is a money loser.
But we must keep in mind the end goal. Increased efficiency means greater net revenues to all parties involved. I take seriously my job as Chairman of this Subcommittee, and I intend to see that that remains our focus. My purpose then in calling today's hearing is to attempt to set in motion a consensus-seeking effort not unlike that of two years ago, which ultimately resulted in the passage of a bill which President Clinton was eager to sign, the Royalty Fairness Act.
I understand that there are naysayers within Congress, some of whom may believe I have tried to stack the deck in this oversight hearing. I disagree strongly with that assertion, but this will not be the final hearing on royalty-in-kind. And we will hear from other witnesses in September who may perhaps have fundamental differences over whether or not R-I-K is an idea worthy of pursuit.
Furthermore, I have agreed to our Minority's request to have Representative Carolyn Maloney of New York as our first witness today, given the fact that she seems to have an abiding interest in royalty collection. And certainly I share that with you. I welcome you here today, Mrs. Maloney, and now I recognize the Ranking Member, Mr. Carlos Romero-Barceló for his opening statement.
[Briefing paper may be found at end of hearing.]
STATEMENT OF HON. CARLOS ROMERO-BARCELÓ, A DELEGATE IN CONGRESS FROM THE TERRITORY OF PUERTO RICO
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Mr. ROMERO-BARCELÓ Thank you very much, Madam Chair, and we appreciate the opportunity to review the possibilities for a royalty-in-kind program in the Federal oil and gas leasing program.
And it is particularly agreeable to have our colleague, Carolyn Maloney, Representative of New York, join us here today. Representative Maloney has indeed shown a great interest in the Federal royalty program for several years now. And her insight and her comments will be very welcome on this Subcommittee.
The question of whether the Federal Government should take its oil and gas royalties ''in kind'' presents a lot of interesting possibilities. Of course, we are interested in any option that purports to improve services at a reduced cost.
We share the Chair's interest in developing more simple, certain, and efficient methods of collecting oil and gas royalties. We are pleased to learn that a group of the independent oil and gas producers, through their trade associations, is working together to develop a royalty-in-kind proposal; just as we are pleased that the Minerals Management Service, under the able leadership of Ms. Cynthia Quarterman, is aggressively examining the question. The oil-producing states too have a valuable role to play in this discussion.
However, it is a bit unsettling to hear—after aggressive lobbying by the states and oil and gas industry officials, and over the initial objections of the Minerals Management Service—that the Royalty Fairness and Simplification Act of 1996 that was signed by President Clinton just one year ago should be cast aside along with the improvements made to the royalty management program and replaced with an in-kind marketing program. This is almost a 180 degree turn from what the oil industry and states were clamoring for during the last Congress.
To a certain degree, I am being facetious. However, our experience with the Royalty Fairness Act illustrates an important factor to bear in mind. We must all be very cautious and extremely deliberative in our consideration of the radical idea of replacing the traditional in value royalty payment with a royalty-in-kind program.
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The Federal Government is the largest single owner of oil and gas resources in the United States. What would be the consequences of changing the Federal role from royalty collector to oil and gas marketer? What safeguards would be necessary to assure that the taxpayers will receive their fair share from the development of our nation's oil and gas resources?
Have we adequately considered the consequences of enabling the Federal Government to dictate market price by virtue of its market power? How would the various segments of the oil and gas industry respond to having the Federal Government in the oil business?
We must know the answers to these and other critical questions before we set about writing and considering legislation. Particularly one of the great concerns is we are going away from government being involved in many activities, and we are now asking the government to get involved being an oil marketer. That is a very, very step going away from where we are trying to go in many other areas.
I think our experience in Puerto Rico has been that the government's participation in businesses that are most appropriately private enterprise is a bad, bad experience. I think probably the worst marketer in the world would be the government. Because, clearly, if it is not handled correctly, a U.S. royalty-in-kind program could seriously disrupt the domestic petroleum markets. So we must move slowly and carefully to fully examine this idea.
We have a great deal of research and analysis to do before we can say with any degree of certainty that royalty-in-kind is better than in-value royalty. And there are others beyond these distinguished witnesses here today from whom we should hear, as our Chair has already indicated.
For instance, none of the major oil and gas corporations are on the witness list here today. I hope we will gain the benefit of their views at the next hearing in September when we will also hear from witnesses invited at the minority's request.
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Royalty-in-kind does offer interesting possibilities, but it is no panacea to problems encountered with the current in-value royalty program. Suggesting any specific, mandatory change to the Federal royalty management program at this point in time is premature.
Only after additional study and experience, which MMS can gain through its ongoing efforts and we in Congress can gain through additional oversight hearings, can the subcommittee begin to consider what, if any, changes are necessary to the authorizing statutes. With that message of caution, I join the Chair in welcoming our witnesses today.
[Prepared statement of Mr. Romero-Barceló follows:]
STATEMENT OF HON. CARLOS ROMERO-BARCELÓ, A DELEGATE IN CONGRESS FROM THE TERRITORY OF PUERTO RICO
Madame Chair, we appreciate the opportunity to review the possibilities for a royalty-in-kind program in the Federal oil and gas leasing program.
It is particularly agreeable to have our colleague, Representative Carolyn Maloney of New York, join us here today. Representative Maloney has shown an interest in the Federal royalty program for several years now. Her insights and comments will undoubtedly be of great value to the Subcommittee.
The question of whether the Federal Government should take its oil and gas royalties ''in kind'' presents many interesting possibilities. Of course, we are interested in any option that purports to improve services at reduced cost.
We share the Chair's interest in developing more simple, certain and efficient methods of collecting oil and gas royalties. We are pleased to learn that a group of the independent oil and gas producers, through their trade associations, is working together to develop a royalty-in-kind proposal. Just as we are pleased that the Minerals Management Service, under the able leadership of Ms. Cynthia Quarterman, is aggressively examining the question. The oil-producing States, too, have a valuable role to play in this discussion.
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However, it is a bit unsettling to hear—after aggressive lobbying by the States and oil and gas industry officials—and over the initial objections of the Minerals Management Service—that the Royalty Fairness and Simplification Act of 1996 that was signed by President Clinton just 1 year ago—should be cast aside along with the improvements made to the royalty management program and replaced with an ''in-kind'' marketing program. This is almost a one-hundred and eighty degree turn from what the oil industry and states were clamoring for during the last Congress.
To a certain degree, I am being facetious. However, our experience with the ''Royalty Fairness'' Act illustrates an important factor to bear in mind.
We must all be very cautious and extremely deliberative in our consideration of the radical idea of replacing the traditional ''in value'' royalty payment with a ''royalty-in-kind'' program.
The Federal Government is the largest single owner of oil and gas resources in the U.S. What would be the consequence of changing the Federal role from royalty collector to oil and marketer?
What safeguards would be necessary to assure that the taxpayers would receive their ''fair share'' from the development of our Nation's oil and gas resources?
Have we adequately considered the consequences of enabling the Federal Government to dictate market price by virtue of its market power?
How would the various segments of the oil and gas industry respond to having the Federal Government in the oil business?
We must know the answers to these and other critical questions before we set about writing and considering legislation.
Because, clearly, if not handled correctly, a U.S. royalty-in-kind program could seriously disrupt the domestic petroleum market. So, we must move slowly and carefully to fully examine this idea.
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We have a great deal of research and analysis to do before we can say with any degree of certainty that ''royalty in kind'' is better than ''in value royalty.'' And, there are others beyond those distinguished witnesses here today from whom we should hear. For instance, none of the major oil and gas corporations are on the witness list today. I hope we will gain the benefit of their views at the next hearing in September when we will also hear from witnesses invited at the Minority's request.
''Royalty in kind'' does offer interesting possibilities, but, it is no panacea to problems encountered with the current ''in-value'' royalty program. Suggesting any specific, mandatory change to the Federal royalty management program is premature. Only after much additional study and experience—which MMS can gain through its ongoing efforts—and we in Congress can gain through additional oversight hearings—can the Subcommittee begin to consider what, if any, changes are necessary to the authorizing statutes.
With that message of caution, I join the Chair in welcoming our witnesses today.
Mrs. CUBIN. Thank you. And now for our first witness, Mrs. Maloney, the Representative from New York. Welcome.
STATEMENT OF HON. CAROLYN MALONEY, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK
Mrs. MALONEY. Thank you very much, Madam Chairwoman, and other members of the Subcommittee. I appreciate very much the opportunity to testify today. I would like to request that my entire testimony be put in the record as whole, but I have a very, very brief synopsis of it.
The American taxpayer has lost out on nearly $2 billion in unpaid oil royalties since 1980. I appreciate very much the efforts on the part of the Department of the Interior and the Department of Justice toward correcting this debt. However, I do not believe that collecting royalties-in-kind will serve taxpayers well or the Federal Government.
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Let me bring you up to date very, very briefly on the oil royalty situation. Last year, it came to the attention of the House Subcommittee on Government Management, Information, and Technology, on which I serve, that several oil companies had significantly underpaid their Federal oil royalties. The information came through the Department of Interior's Task Force on California Valuation.
The task force revealed that the royalties paid were much, much lower than they should have been because they were based on the posted price of the oil rather than the real economic value of the oil. The states who lost out in the undervaluation are pursuing their losses. The State of California won a $345 million settlement from major oil companies. Alaska, Texas, Alabama, New Mexico, and Louisiana have also won settlements.
The Department of Interior and the Department of Justice are both investigating the undervaluation reports. The Department of Interior has issued bills for $440 million in unpaid royalties. And the Department of Interior has proposed regulations on Federal oil royalty valuation, which bases the price of oil royalties on the New York Mercantile Exchange market price and the Alaskan North Slope spot prices, which is a standard oil price that the oil companies use.
This came out in the task force report from the Department of Interior, and this is the basis of price for the oil companies. If it is the basis of price for the oil companies, it should be the basis of price for the Federal Government. Here is the key. Those proposed new regulations would bring in an additional $100 million annually. It is money that is owed to the American people and to the Federal Government.
As you know, the industry is interested in a substitute system. They would prefer to pay the royalties-in-kind. Such a deal would force the Federal Government into the oil business, and it would cost the citizens, the taxpayers money.
Here is what would happen under an in-kind system. Oil companies hand over oil as payment. The Minerals Management Service then contracts out to marketers. The marketers then sell to refiners. The profits from the oil are partially eaten up in paying the marketing costs, and American citizens and the Federal Government get jipped. It simply costs the government too much to get rid of the oil.
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Let me give you one example of how this might work. I see that Devon Energy is here to testify today as an oil producer. But what you all might not know is that Devon Energy is also a marketing corporation. The royalty-in-kind proposal gives a company like Devon the option of paying the government its royalties in oil, then being paid by the government to market it.
I don't mean to single out Devon Energy, which is an outstanding company. These practices are quite common in the industry, but they seem downright unfair when oil companies are making money at the expense of hardworking taxpayers.
You have heard and will hear today that the MMS, Minerals Management Service, has changed. You will hear that it is making sincere efforts to change its valuation rules to assure the collection of real value. You will hear that it is working to correct the flaws in its current royalty-in-kind program and to expand and improve that system.
Despite the progress, I don't believe the Federal Government has any business playing J. R. Ewing from the old Dallas television series. The Interior Department does not have the culture, the incentives, or the equipment to become an effective competitor. There are $4 billion in revenues at risk. I encourage other reforms of the Royalty Management Program.
Earlier this year, I introduced the Royalty Collection Reform Act, which would move the program from the Department of Interior to the Department of Treasury to better ensure the collection of money. I believe this is a better solution than shortchanging taxpayers to the advantage of the oil industry.
I would just like to add that last year an important bill was passed out of Congressman Horn's Subcommittee on Government Management and Technology, and I worked very closely with him on this reform. And I just mention it because it is similar in a sense. We did a study that showed $55 billion was owed the Federal Government in loans, fines, fees—this is how we started looking at the royalties—and royalties.
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And one of the things that we did to modernize collection is to move collections to a centralized collector whose purpose and focus is collecting money, the Department of the Treasury. For example, the Education Department had many loans that they weren't collecting, but their prime focus and purpose is to educate, not to collect money.
And so if you put it into a collector's hands after a certain period of time where the central agency tries to collect, then they will focus on collecting it as their prime and main mission. So I just mention it. And according to the Department of Treasury, our bill has brought in roughly—they estimate will bring in $10 billion over the next five years.
I would like to put three graphs into the record if I could that point out simply the proposals. This is the royalty-in-kind proposal and the new regulations that MMS has put into effect. The new regulations that they are calling for would have the government royalty based on the market price, which is the price that the oil companies pay.
If it is good enough for private sector, why shouldn't it be good enough for government. The royalty-in-kind proposal will have the government royalty—the market price could be diminished by the marketing expenses and other expenses that may be involved.
This is a graph of how an oil company—many of our large oil companies are integrated and formed. They have a production affiliate, a marketing affiliate, a transportation affiliate, and a refining affiliate. And so there could be built-in costs before we would get the real revenue. It is much simpler to just get the market price.
And, again, I give the current system, which is very simple. You have the oil. You have the market price. You have MMS collecting the market price for the government's oil. Under the royalty-in-kind, you would have MMS becoming hugely involved in marketing to various contractors, to various oil refineries, and there will be a lot of government cost and expense.
And it seems to me as we are working, as we speak on the floor jointly in a bipartisan way to balance the budget and to invest in values and really run government more efficiently that the more efficient way to collect oil royalties is with the market price, the market price that, in fact, serves the private sector. And I thank you, and I tried to be brief, and I——
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Mrs. CUBIN. And you did a good job.
Mrs. MALONEY. [continuing] would like to put this in the record.
Mrs. CUBIN. Without objection.
Mrs. MALONEY. And if there are any questions, I would love to answer them. In any event, I look forward to working with you.
[Prepared statement of Mrs. Maloney follows:]
STATEMENT OF HON. CAROLYN B. MALONEY, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK
Thank you Madam Chairman and Members of the Subcommittee.
Background
Last year, in a hearing of the House Subcommittee on Government Management, Information, and Technology, the Subcommittee discussed the findings of the Department of Interior's Interagency Task Force on California oil valuation at great length. According to the report, major oil companies underpaid Federal royalties by posting the price of oil below the real economic value of the oil which the companies determined to be the Alaskan North Slope (ANS) spot price.
On September 24, the Committee on Government Reform and Oversight released a report entitled, ''Crude Oil Undervaluation: The Ineffective Response of the Minerals Management Service.'' This report contains three findings that pertain to this hearing: 1) the Federal Government has received oil royalties below market value, 2) the oil undervaluation problem exists nationwide, and 3) the MMS royalty in kind program may have left Federal financial interests unprotected.
Since the release of the Task Force and the Committee report, the Department of Interior (DOI) has proposed new regulations on Federal oil royalty valuation which bases the price of Federal oil royalties the New York Mercantile Exchange (NYMEX) market price and the Alaskan North Slope (ANS) spot price.
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Royalty In Kind
As you know, MMS' proposed regulations have produced voluminous comments, especially from industry. A surprising theme repeated throughout the industry comments on Interior's proposal is that the Department should cease collecting royalties in value and take its production in kind, meaning the Federal Government should enter the oil business.
Compare this to the arguments we heard last year in support of the sale of the Elk-Hills Naval Petroleum Reserve. In managing that Reserve, the Department of Energy sold Federal oil. But last year, many of these same industry advocates were arguing that the Department of Energy, as a government entity, simply had no place in the oil business. But today, they urge us to force the Department of the Interior to enter the market on a scale that would eclipse, by several fold, the DOE's Elk Hills program.
It was only last year that this Congress passed into law, the Federal Oil and Gas Royalty Simplification and Fairness Act. This legislation imposed new requirements on the Department of Interior to follow in the collection of royalties. As I understand it, the Minerals Management Service has yet to fully implement these requirements which has caused a flurry of rulemakings, task force groups and other re-direction of resources. Now industry is advocating even more drastic changes—changes, which if implemented in full would essentially scrap these recent reforms.
I believe the real impetus behind industry's royalty in kind push is to avoid paying oil royalties based on market price as suggested in the new proposed oil valuation regulations.
Forcing the government to take the royalty in kind will trap the government in the very posted price system that does not reflect value. Industry believes that bidding the production out at the lease will safeguard the public's revenue interest against posted prices. However, if the real independent producers cannot obtain market value, how can the Federal Government? The fact is that those that could purchase at the lease—the major integrated companies—have an interest in getting access to cheap oil. And those others that more typically participate—brokers and marketers—would not survive if they could not profit from the difference between posted price and real value.
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Industry also suggests that MMS use marketing middlemen to sell the government's in kind production. This Subcommittee is fortunate to have oil marketers before it today, and I would urge you to question them closely about how use of marketing middlemen would protect the public's revenue interest.
For example, Devon Energy, which is here to testify in support of a government royalty in kind program, is not only a producer, but a marketer through its subsidiary, Devon Marketing Corporation. Devon's SEC filings indicate that its marketing affiliate has purchased over 80 percent of its production from third parties over the last few years. Logically, it is thus a potential purchaser of the government's royalty in kind production. Those same documents indicate that Devon Marketing purchases third party oil production at the field postings and resells it at a premium over posting.
I do not mean to single out Devon Energy. As I understand it, the practices of its marketing affiliate are common.
But as potential purchasers of the government's in kind production, I would urge the Subcommittee to ask these industry marketers the following questions. Would you follow your normal practice of purchasing product at the posted price for in kind production? And, if not, what percentage of the premium received by your marketing affiliate would you share with the Federal Government and what would you keep as a ''marketing fee''?
My concern is simple. In the past, MMS operated its royalty in kind program as a source of cheap oil for independent refiners. The current proposals suggest that the economic advantage of cheap government oil will simply be transferred from small refiners to marketers. Under either scenario, the public's revenue interests are left out of the equation.
I have also heard repeatedly from industry that MMS simply has no understanding of the crude oil market. If it is true that MMS' knowledge lags the market, how can we hope to assure that MMS will on a timely basis be able to evaluate the performance of its marketing agents? And, if it does take five, 10 years for MMS to catch up, as we have seen in the past, what protection will exist that the public will not be short-changed?
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In referring back to Interior's task force report, our Committee found example after example of how oil companies were very successful in losing MMS auditors in a maze of oil transactions. Let me quote from the report:
On Page 18, the report states, ''Most oil from Federal oil and gas leases is produced by integrated companies that transfer production from their production arm to a trading or refining arm. After this initial non-arm's-length transfer, oil produced from Federal leases loses its identity in companies' accounting systems so that its price in subsequent transfers cannot usually be determined.
And on Page 49-50, the report says, ''After transferring Federal crude of a specific type to a company's trading division, the distinction between Federal and non-Federal crude oil was lost. Federal crude oil was not specifically invoiced in companies' records after internal transfers, so it is unlikely that gross proceeds in excess of posted prices can be traced to the production of specific Federal leases.''
As much as I admire the efforts of the Secretary to make improvements to Interior's Royalty Management Program, I believe the major oil companies have and can continue to bury the Royalty Management Program audit teams in a maze of company trading transactions. Furthermore, the oil companies have made no secret of their desire to use legal roadblocks and endless appeals to prevent the release of their affiliate's records. That's why I believe that using spot prices like the ANS and NYMEX is by far the most efficient, accurate and least bureaucratic method to value royalty on.
Conclusion
You have heard and will hear today that MMS has changed. It is making efforts to change its valuation rules to assure the collection of real value, and I applaud those actions.
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But, despite this progress, I simply not believe that the Federal Government should enter the oil business. The Interior Department does not have the culture, the incentives, or the equipment to become an effective competitor. Congress should not risk $4 billion in revenues by forcing MMS to try and recreate itself into something that in reality it cannot effectively become.
Reform at MMS is possible. I too have called for further reforms of the Royalty Management Program. I have introduced the Royalty Collection Reform Act, which would move royalty collection to the Department of Treasury's Financial Management Service (FMS) to better insure that funds owed the government are collected. FMS can collect Federal royalties accurately without the need for a full blown oil royalty in kind program.
Thank you.
[Graphs follow:]
INSERT OFFSET FOLIOS 24 TO 27 HERE
Mrs. CUBIN. Thank you. I do have just a couple questions. First of all, I know that you know this, but just for the record, when Federal minerals are produced in a state, then the state shares in the royalties at 50 percent.
And so before I came up here today, I think want to say this because I want you to understand—not just you but everyone to understand—how not only do I think it is the right thing to do to collect the appropriate penny of the appropriate amount—every single penny that is owed to the government in royalties, but it is also for every constituent in my state.
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Because I went back and looked up the data published by MMS on all the royalties collected from Federal leases within each state since the advent of the Mineral Leasing Act, and it may surprise you to learn this that New York has had natural gas production from Federal mineral estate totaling $54,327 in royalties from 1920 through 1995.
Now, let us compare that with the total of royalties paid into the Treasury from the Federal leases in Wyoming over the same period of time. According to MMS, over $6,680,000 of royalties were paid from Wyoming, and so, obviously, our schools and our communities, our highways—it is very important to me that we get every single penny to which we are entitled. And we agree very strongly on that.
There may be some disagreement. I think that is yet to be told. But I want to ask you this question. Did your graphs show the amount of money that the Federal Government spends on litigation, on enforcement, and audits, and all of those kind of things—expenses that go into the current collection process?
Mrs. MALONEY. Well, we hope the regulations will fix some of that. My graphs had no numbers on them at all. And as you know, their new regulations greatly simplify their collections process, projecting to collect on the Alaskan North Slope prices and the New York Mercantile Exchange, as opposed to the posted prices.
I would think that moving to that system would cut out a lot of litigation just by common sense, that there is nothing to litigate. I mean, it is very clear. Here is the price that the private sector pays. Here is the price that the government pays. It is the same.
Mrs. CUBIN. Well, unfortunately, it really isn't that simple. I live right in the middle of an oil and gas field, and the problem that I see at this point in time with the proposed rule is that what this rule will do is move the point of valuation farther from the wellhead or from the border of the lease.
And so that the price then will include some beneficiation rather than the actual price at the wellhead, and that is where the tax ought to be assessed, in my opinion. You said that $51 billion or $55 billion is owed in uncollected royalties. Is that correct?
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Mrs. MALONEY. That was to illustrate centralizing collections in the Treasury. This report that we did was one of 100 agencies where they reported back what was owed to them, and this was not just an oil report. This was all that was owed the Federal Government in uncollected——
Mrs. CUBIN. In minerals?
Mrs. MALONEY. No, no, no, in everything.
Mrs. CUBIN. Oh, OK.
Mrs. MALONEY. In everything—education, agricultural loans, small business loans, loans, fines, fees, royalties, and other areas. This was what was owed to the Federal Government that was not collected. And Congressman Horn and I put in a bill to improve collections, not just for royalties but across the government, that modernized it, simplified it, and, very importantly, put collections in one office whose mission it was and focus was to bring revenue into the Federal Government.
Mrs. CUBIN. Thank you.
Mrs. MALONEY. And that has helped bring in—in fact, we are working on our second report, and I will be glad to share it with you with Mr. Horn of what has come in since our bill went into effect. But the Treasury projects that having done what we did, centralizing collections in Treasury, will improve collections across our government by they said $10 billion in 5 years. That is a lot of schoolteachers. That is a lot of police officers. That is a lot of investment in the interior and other things in our parks that we need money for.
I just mentioned that as a way of possibly improving collections instead of having the Department of Interior that has so many important responsibilities to possibly let the Treasury Department, which is collecting now across government, likewise collect royalties. Maybe that is another issue maybe that is not just in-kind, but I just brought it up since it had been successful in bringing in revenue. And that is one of the focuses of the in-kind hearing that you are having now, to bring in the revenue. In any event, I appreciate your time and of all the members here.
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Mrs. CUBIN. Thank you. Did you have any questions, Mr. Barceló?
Mr. ROMERO-BARCELÓ. First of all, I would like to thank Mrs. Maloney for her testimony and for being here with us——
Mrs. MALONEY. Thank you, Governor.
Mr. ROMERO-BARCELÓ. [continuing] and helping us and educating us. She knows more about this problem than I do. I am just beginning to learn about it. But, Madam Chair, I would like to suggest that we ask for the Administration to give us an estimate on the cost of litigation for the collection of the——
Mrs. CUBIN. Certainly.
Mr. ROMERO-BARCELÓ. OK. Thank you. Thank you, Madam Chair. And I just have a couple of questions for Mrs. Maloney. Do you know what has been the experience in those countries like Venezuela and Mexico where the government is involved in the business of marketing oil?
Mrs. MALONEY. I have not studied those countries. I could look at it and get back to you.
Mr. ROMERO-BARCELÓ. Well, the experience is very, very, very bad for those countries. I mention that because everywhere that the government gets involved in something that is capitalistic as marketing, they are never successful.
So if that is an option, this will be analyzed from all angles because it is very—as I said, the experience that we have had also in Puerto Rico has been a very bad experience. What they had in England and other countries has also been very bad when the government gets involved in selling goods or services.
The other thing I would like to ask you, Mrs. Maloney, is have you been in touch with the Secretary of the Treasury or with anyone in the Federal Management Service about how they would go about it and whether they would be interested in handling the services of collecting the royalties?
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Mrs. MALONEY. Absolutely. I have talked several times with Cynthia Quarterman and also with Secretary Babbitt, and I applaud the Administration. They really appointed a task force that came forward with the first government report that showed the undervaluation and took steps to correct it. And I think that they have been innovative, and they have worked very hard on it, and that they have done something constructively to correct a problem. And I applaud them for their efforts.
Mr. ROMERO-BARCELÓ. I am talking about the suggestion that you made that the collection of royalties be delegated to the Department of Treasury, not the Interior.
Mrs. MALONEY. I have talked to Treasury officials, but I have not met with the Secretary, and I will try to meet with the Secretary and discuss it with him and see what his viewpoints are on it. And I put forward the proposal only with the deepest respect of the Department of Interior and the fine job that they are doing but in probably helping with the management.
What we are doing across government is each agency will have 6 months to collect what is owed to them. Then it moves to the Department of Treasury where they then centralize it and try to bring it in through a centralized method, which has been working very well.
Mr. ROMERO-BARCELÓ. I just asked that question because the idea to me seems very good because, obviously, the Treasury Department is much more trained to collect any kind of taxes or royalties than anybody else in the government. So——
Mrs. MALONEY. I think that a lot of times in government we are very shortstaffed, and we don't have enough time or energy or personnel to do all the many things that we need to do. And a lot of times your main focus is that of your main purpose which in the Department of Interior is our resources, our parks, our minerals, our oils, and not necessarily the management.
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And perhaps that would be a way, but I would, you know, of course, want to work with Secretary Babbitt. I think he has done an absolutely extraordinary job, and I might add that even though there have been published reports about undervaluation of oil for many, many years, this was the first time the Department of Interior appointed a task force, issued a report, then acted on the report's recommendations constructively to correct it.
And I think they have done—I think that I am going to recommend them for one of Vice President Gore's—what are they—the Hammer Awards for government employees who do a good job because I think they have done a wonderful job with those.
Mr. ROMERO-BARCELÓ. Thank you, Mrs. Maloney.
Mrs. MALONEY. Thank you.
Mrs. CUBIN. Mr. Thornberry, did you have—Mr. Brady? Mr. Dooley?
Mr. DOOLEY. Yes. Mrs. Maloney, before you leave, I just wanted to ask one question. I appreciate all the work you have done.
Mrs. MALONEY. The last time I saw you you were on the floor.
Mr. DOOLEY. I know it.
Mrs. MALONEY. Now, you are back up here. I think when I left my office you were on the floor giving a good speech.
Mr. DOOLEY. That is right. But, you know, a lot of it is appreciated—a lot of the work that you have done in terms of ensuring that taxpayers are getting their fair share of the royalties. I guess I come at this representing a lot of independent producers, and we are a little bit concerned with some of the proposals in terms of how are we going to ensure that the price is going to be reflective of the real price if they are being paid for their product.
And as I was reading your testimony, I was somewhat struck because it seems like there is one sentence in your testimony that almost expresses a similar concern, and when you were talking about how the in-kind will be difficult because you are concerned you will not be able to safeguard the public's revenue interest against posted prices, you go on to say, however, if the real independent producers cannot obtain market value, how can the Federal Government.
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And my concern is is you are making a statement there that independent producers are not necessarily receiving what will be the fair market value, which MMS and I think which you are proposing will be reflected by an ANS price if you are from California, as I am. And some of us are not convinced that that is actually going to occur. In your statement, you state that they are not receiving that now.
Now, I hope that you are sensitive as we try to move forward, you know, to make sure that that price of which the independents are going to be paid on for their royalties are going to be a function of is, in fact, the price that they are receiving for the oil. And do you acknowledge—is this a problem? I mean, it seems to be as you have stated in your testimony.
Mrs. MALONEY. I agree absolutely, completely, Congressman, and, in fact, many independent producers have written my office and actually have come by personally to see me in support of the work of the Subcommittee on the valuation of oil.
Mr. DOOLEY. So would that mean that you would then be opposed to what MMS is proposing in terms of using a benchmark at ANS for independent producers?
Mrs. MALONEY. No. I think that you need to—the independent producers want the true value of the oil. Right? And that is the value that we want, which is the——
Mr. DOOLEY. They want to pay royalties on the price of the oil—on what they are being paid for the oil that they are selling?
Mrs. MALONEY. Right, exactly, exactly.
Mr. DOOLEY. Well, what you are saying in your testimony is that sometimes they are not receiving what the fair market price is and which we are assuming that what MMS is proposing is that the fair market price will either be a New York Exchange price or an ANS price?
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Mrs. MALONEY. Yes.
Mr. DOOLEY. And so, you know, my concern is if you are acknowledging they are not getting paid that fair price now, we are going to implement a system which is going to ensure that they are paying higher royalties than what they should.
Mrs. MALONEY. Well, we should separate the independents from the majors in the regulations.
Mr. DOOLEY. Thank you.
Mrs. MALONEY. But, you know, what we looked at in our committee which was getting the best price for the American taxpayer. And the task force showed that the price that the oil companies themselves were paying was Alaska North Slope in the case of California, or the New York Mercantile Exchange for the others. I am not an expert on the oil industry. We were not looking at it except for in a management role, which is the role of the committee.
I do know that several independent producers from California and other states came to my office in support of having a system that was not posted prices but, in fact, Alaska North Slope. So they did, you know, support that work. And whatever their concerns are, I would like to listen to them even more.
But in terms of the work of the committee and the reports coming out of MMS and the proposed system that MMS has suggested in the regulations, the ones that came to my office were totally supportive of it. Now, if there are other independent producers who have a different problem, I am not aware of it.
And as you pointed out, I don't represent an oil state. I was not coming at it from a state interest. I was coming at it from the purpose of the committee on which I serve, which is better management of government resources and reports that come forward that oil is greatly undervalued and that California, Wyoming, and others—in fact, it was California that the whole issue really highlighted out of the collection system of the State of California.
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Mr. DOOLEY. Well, I think most of the independents or representatives of their associations have come out in opposition and expressing some real concerns about the valuation process; at least that is what the associations are communicating to me. The other point I would make is——
Mrs. MALONEY. What is their problem with the valuation process?
Mr. DOOLEY. Well, precisely what you said in your testimony. I mean, what you stated in your testimony was, however, if the real independent producers cannot obtain market value, how can the Federal Government. You have made a statement that independent producers are not obtaining fair market value. What MMS is proposing is that fair market value can be determined by an ANS benchmark. And you have already acknowledged that that is not happening.
And so my concern is that you are stating in your testimony that my guys, my independent producers are going to be paying a higher royalty than what they should based on what they are receiving for the oil that they are producing, and that to me is an inequity that we need to be concerned about.
Mrs. MALONEY. We agree some of the independents feel that the majors give them an inequity, but, again, we were acting on the report of the task force that said the majors—and the task force report focused on majors, not the independents—said that the major oil companies—10 to be exact—were basing their prices internally on Alaskan North Slope and the New York Mercantile Exchange, and that the posted prices were much lower than those two standards.
If independents—you know, maybe there should be separate regulations for the independents given the specific problems that the independent oil companies have. And I would like to go back and meet with some independent oil companies and become more aware of their particular problems.
But, as I said, you know, I am not the Department of Interior. We were looking at a report that oil was greatly undervalued, and we acted on it. But you raised an important point, and I agree with the great Congressman from the great State of California, which actually brought this attention to the national level in the first place.
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Mr. THORNBERRY. [presiding] Mr. John, you have something?
Mr. JOHN. Yes. I don't particularly have a question for the gentlelady from New York, but with the pleasure and the OK of the Chairman, I would like to make just a little observation, a little statement about the importance of this issue.
Being from Louisiana, oil and gas industry is very, very important. As I served in the legislature, $1 billion in royalties is part of the Louisiana budget for the State of Louisiana. So this issue is very, very important.
And, moreover, than just the State of Louisiana, my district, which sits on the Gulf of Mexico and bordered by the State of Texas, is what I like to call the heartbeat of the offshore oil and gas industry of the Upper Gulf of Mexico. So this issue is very important and very vital to my constituency, the oil and gas industry, and the taxpayers of the State of Louisiana.
I think we must keep in mind as we go through these proceedings that I believe the bottom line, and to make it as simple possible, is that we need to look at the cost associated with the proposed system and the systems already in place. What does it cost MMS now to evaluate the problems that are caused, and what is the value? Is it wellhead or is it whatever? Or what is it going to cost to revamp a collections agency to go toward the in-kind.
So I think if we keep that in mind, that is the ultimate decision that this Committee is going to have to do and decide upon. So I just wanted to make a statement that it is very, very important to my district in my State of Louisiana. And I thank the Chairman of the Committee for holding these hearings. Thanks.
Mrs. MALONEY. Well, I thank you. And many of the attorney generals of the states that many of you represent that are oil-producing states have been in contact with our offices and the central committee, most of whom are supportive of our efforts to revamp the system.
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Mr. JOHN. Well, this issue, like many others, has its proponents and opponents, but I am anxious to hear the gentlemen from the—or the testimony from the State of Texas that actually has an in-kind program in the state on state waters and state lands to see how it is working. I think I am interested in hearing that testimony. Thanks.
Mrs. MALONEY. Well, I look forward to reading about it too. Thank you very much. I appreciate your time.
Mr. THORNBERRY. Mrs. Maloney, thank you for your testimony. And certainly if your schedule permits, we would certainly invite you to stay and sit up on the dais and listen to the testimony from the State of Texas where they have had such a program since 1973. I think it would be helpful for everyone.
We would call the next panel now; Jim Magagna, Director, Office of State Lands and Investments, Office of Federal Land Policy, State of Wyoming; Spencer Reid, Deputy Land Commissioner, Texas General Land Office; and David Darouse, Mineral Revenue Regional Auditor Supervisor, Department of Natural Resources, from Baton Rouge, Louisiana.
Gentlemen, we appreciate each of you being here today and willing to share your perspectives with us on this issue. Mr. Reid, we will let you start, and we will just go down the line from our right to left.
STATEMENT OF SPENCER REID, DEPUTY LAND COMMISSIONER, TEXAS GENERAL LAND OFFICE
Mr. REID. Mr. Chairman and members, Texas Land Commissioner Garry Mauro appreciates the invitation to appear before the Subcommittee today and to discuss the Texas royalty-in-kind program and regrets that he is unable to personally attend, and he has asked that I speak on his behalf.
One thing I would like to point out is we were asked to bring comments about our experience with our program, and these comments are not intended to address any particular proposals that are pending. We haven't addressed anything in here like that.
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We have been very pleased with the results of our in-kind programs and are glad to share this information. While royalty-in-kind may not cure all of the disputes that arise between royalty owners and producers, our experience in Texas has been that it does provide a means to substantially reduce royalty disputes, valuation disputes particularly, reduce costs to both the states and the lessee, and provide the royalty owner with an opportunity to obtain an enhanced return.
For those of you not familiar with the Texas General Land Office, it is headed by an elected state official. The principal duty he has is to manage 20 million acres of state lands of which about 15 million have minerals under them, of that about 5 million is offshore of Texas either in the Gulf of Mexico or in the various bays of the state.
And all of the land there is dedicated to the Permanent School Fund or one of the Permanent University Funds. The Permanent School Fund last year—the General Land Office deposited about $155 million, which I know in Federal standards isn't a lot of money, but for Texas that has allowed us to build on a fund now approaching $14 billion for support of public education in Texas.
There is also the Permanent University Fund in Texas that has another—it has got over $5 billion that is operated by the University of Texas. It has a lot of land out on Permanent Basin. As to the relative size of our production, we have about 33 billion cubic feet of natural gas, which if Texas were a producer in its own right would put us in probably the top 50 producers in the country.
The Texas program has been going on for about 14 years. It has accelerated in the recent years. Over that time, we have enhanced our income to the Permanent School Fund by $11 million in gas and $5 million in oil. And another component of the state program which is something that really is kind of the gist of our program, we save state agencies in Texas over $90 million over that same period of time in energy costs by selling them state gas from state leases directly to state consumers.
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Our in-kind program originated in the early 70's. The legislature passed the first statutory authorization for the program in 1973. From then until the early 80's, we took relatively small volumes of gas and sold them in the marketplace just like a marketer.
In 1983, we began marketing gas directly to end-users, and by the end of 1985, it was expanded to include state agencies. This expanded programs concentrated on sales to agencies, universities, and public facilities. The goals of the program were twofold: first, to generate more revenue to the Permanent School Fund and to save money for the state agencies.
The Texas legislature has consistently supported the program and in recent years has enacted laws that assured the smooth operation of the state program. Any state agency contract for over 100 Mcf of gas per day must be submitted to the General Land Office to see if we can provide state gas and get them a better price. And then we are able to transport gas and gas utility lines. They are prohibited from—well, they are required to carry state gas if they have capacity if it is destined for a state agency.
In addition to the natural gas in-kind program, the Land Office takes approximately 2,400 barrels of oil per day and sells it in-kind. That is 45 percent of our total production, our total royalty share. The oil is sold under 6-month contracts at bid sales. Prices are bid at premiums to posted prices, and at the last sale in April, the premium was as high as $2.08 over the commonly used posting.
Last fiscal year, the gas program sold approximately 9.1 Bcf to state agencies and 2.6 Bcf were sold on the spot market. Our total gas sales represent about 35 percent of our total production—our total royalty share, let us say. Our spot market sales assure that adequate supplies have been retained to meet our state end-user program. Gas is currently being taken in-kind from 105 leases, almost all of them offshore.
The contracts are in place with 103 state facilities, 28 state colleges and universities, and six other governmental bodies, including school districts, small cities. Transportation contracts are currently maintained with 35 different pipeline companies and local gas distribution companies. And we maintain a contract for up to one Bcf of gas storage in a facility near Houston.
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Sales of gas on the spot market are sold through monthly solicitations of interest from prequalified gas marketers. We currently have about seven marketers that bid on this. In order to qualify, marketers must show financial stability. But in order to encourage small business participation, the Land Office maintains a credit risk insurance for those contracts.
Since 1973, all state oil and gas leases have provided for the right of the state to take royalty-in-kind upon 60 days' notice of our intent to do so. On some leases, we have been able to negotiate in-kind those that were issued prior to 1973.
Once we have exercised our right to take-in-kind for a particular lease, we make every effort to continue to take gas from the lease in order not to burden the lessee by alternately taking and not taking. We do have the authority to not take. We generally take possession at the point in which it has been made ready for sale or commercial use through the removal of water, natural gas liquids, and impurities.
Costs of transportation and other direct costs, together with the markup or enhancement, which is what the additional royalty paid the school funds is termed, and a set administrative fee that pays for our operating costs of the program are charged to the gas purchasers—the end-user purchasers.
In all but a few cases, prices to the end-user agency are below those available from private sources and are lower than local utility costs in almost every instance.
We make a decision at every sale and the local—the agency is authorized to not buy from us if it is going to cost them money.
Gas and oil producers on state lands have almost been uniformly supportive of both the gas and oil in-kind programs. We don't have specific figures on the administrative savings and other benefits, but they are undoubtedly there. It is a lot easier to account for volumes of oil or gas physically delivered than to account for both volumes delivered and the market value of those volumes.
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Delivering in-kind relieves the producer of the obligation to account for the market value of the gas and relieves the Land Office from the burden of conducting the financial audits of producers. Once accurate delivery is established, the producer no longer needs to be concerned state auditors will dispute the value that they received.
Our programs are so successful we are looking at privatization of our programs or bringing in a gas marketing firm. We put out a RFP last summer. We have gone through the process and got down to the company that we are negotiating final contract with.
The contract provisions provide that we are negotiating for an expansion of our end-user program. They will take a three cents fee for doing that activity. And then the balance of it, if we have overages, essentially works out to a gas sales contract indexed to a pipeline.
I will close by just saying that Texas is very interested in a way to obtain its share of Federal royalties that were paid in-kind. Volume is the name of the game in this business, and we would be very anxious to work with Congress and Interior staff to see if a way can be worked out to do that.
[Prepared statement of Mr. Reid follows:]
STATEMENT OF SPENCER REID, DEPUTY LAND COMMISSIONER, TEXAS GENERAL LAND OFFICE
Ms. Chairman and Members:
Texas Land Commissioner Garry Mauro appreciates the invitation to appear before you to discuss the Texas royalty in-kind program, and regrets that he is unable to be here. He has asked that I speak on his behalf.
The Land Office has been pleased with the results of our in-kind programs and are glad to share information about them with you. While royalty in kind may not cure all of the disputes that arise between royalty owners and producers, our experience in Texas is that it does provide a means to substantially reduce royalty disputes, reduce costs to both the State and the lessee, and provide the royalty owner an opportunity to obtain an enhanced return.
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For those of you not familiar with the General Land Office, please allow me to briefly explain our role. The Land Commissioner, who heads our agency, is an elected official. One of his main duties is to manage the more than 20 million acres of public lands and minerals owned by the various Texas government departments, most prominently, the Permanent School Fund, a trust fund that supports public education in Texas. In the fiscal year ending August 31, 1996, $155 million were deposited in the Permanent School Fund, which, although not large by Federal standards, has nonetheless allowed Texas to create a school endowment worth over fourteen billion dollars. The State's Permanent University Fund, which is similarly structured, is valued at over five billion dollars. As to the relative size of State production, the approximately 33 billion cubic feet of natural gas that represents our annual royalty share would rank the School Fund in the top 50 of the largest producers of natural gas in the United States.
Over the past fourteen years, the Texas in-kind program has enhanced royalty income for our Permanent School Fund by over $11 million in gas royalty and $5.1 million in oil royalty, saved State agencies over $90 million in gas utility bills, and saved untold thousands of dollars for the General Land Office and oil and gas producers by eliminating the need for financial accounting for royalty volumes of oil and gas taken in-kind. The program's past success has led me to seek to expand the program through a new public private alliance that I will describe for you in a few minutes.
The Texas in-kind program originated in the early 1970's. The Texas Legislature passed the first statutory authorization for the in-kind program in 1973. From then until the early 1980's, relatively small volumes of gas were sold in the market to obtain better prices than were being paid in cash royalties. In 1983, the General Land Office began marketing gas directly to end-users and by the end of 1985, the program was expanded to include State agencies.
This expanded program has concentrated on sales to State agencies, universities, and other public facilities. The goals of the program are twofold—first, to enhance income to the Permanent School Fund, the principal beneficiary of State royalty income. The second goal is to reduce gas costs to State facilities by providing State gas at prices below those charged by gas utilities.
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The Texas Legislature has consistently supported the program and, in recent years, has enacted laws that assure the smooth operation of the State program. One such statute requires all State agencies that consume at least an average of 100 Mcf of gas per day to submit all gas acquisition contracts to the General Land Office for review. If the Land Office is able to provide gas at the same or lower cost, it may require the agency to purchase gas from it. Another supportive statute requires all regulated gas utilities to provide transportation of State gas if capacity is available on their systems and it is destined for a state agency. These transportation rates are competitive with those provided to private parties.
In addition to the natural gas in-kind program, the Land Office takes in-kind approximately 2400 barrels of oil per day. This oil is sold under six-month contracts through a sealed bid auction. Prices are bid at premiums to posted prices. At the last sale, held in April, these premiums were as high as $2.08 over one commonly used posting.
Last fiscal year, the gas program sold approximately 9.1 Bcf of gas to State agencies and another 2.6 Bcf on the spot market which represented 35 percent of our total royalty production. Spot market sales assure that adequate supplies have been secured to meet State end-user demand. Gas is currently being taken in-kind from 105 leases, almost all of which are located along the coast. Sales contracts are in place with 103 State facilities, twenty-eight State colleges and universities, and six other government bodies, including school districts and small municipalities. Transportation contracts are currently maintained with thirty-five different pipelines and local gas distributing companies. We also maintain a contract for up to one Bcf of natural gas storage at a facility near Houston.
Sales of gas on the spot market are made through monthly solicitations of interest from pre-qualified gas marketers, of whom there are currently seven. In order to qualify, marketers must show financial stability. In addition, to encourage small business participation, the Land Office maintains credit risk insurance.
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Since 1973, all State oil and gas leases and statutes have provided for the right of the State to take royalty in-kind upon sixty days notice of our intent to do so. On some leases issued prior to 1973, in-kind takes have been provided for by agreement. Once we have exercised our right to take in-kind for a particular lease, we make every effort to continue to take gas from that lease in order not to burden the lessee by alternately taking and not taking. We generally take possession of the gas at the point at which it has been made ready for sale or commercial use through the removal of water, natural gas liquids, and impurities.
Costs of transportation and other direct costs, together with a markup or ''enhancement'' and a set administrative fee are charged to the gas purchasers. In all but a few cases, prices to the end-user agency are below those available from private sources, and are lower than local utility costs in almost every instance.
Gas and oil producers on State lands have been almost uniformly supportive of both the gas and oil in-kind programs. Although I do not have specific figures, the administrative savings and other benefits to both producers and the Land Office are clear. It is far easier to account for volumes of oil or gas physically delivered than it is to account for both the volumes delivered and the market value of those volumes. Delivery in-kind relieves the producer of the obligation to account for the market value of the gas and relieves the Land Office from the burden of conducting financial audits of producers. Once accurate delivery is established, the producer no longer needs to be concerned that State auditors will dispute the prices that the producer received.
The in-kind programs have been so successful that we are now, as I mentioned, starting the process of revising and more than doubling the gas program. The changes in the natural gas marketplace in the past several years have made it possible, I believe, to form a public/private alliance with a gas marketing firm that will bring the very specialized expertise of that kind of operation together with the gas supply and markets that my office can provide, to the benefit of both the State and the private company.
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Last year, we invited over 60 gas marketing firms to submit initial proposals to the General Land Office for just such a public-private alliance. In the invitation, firms were asked to propose plans for their management of our end-user program, the creation of a natural gas liquids sales program, and to purchase the balance of our natural gas supply, approximately 15 Bcf per year at a price linked to the market price, and preferably at a premium. As a result of the responses to that invitation, a marketing firm was selected to begin finalizing a marketing contract by next fall.
It is in this context that the State of Texas is interested in a way to obtain its OSCLA share of production allocated to the States. The name of the game in gas marketing is, of course, volume. These 8(g) volumes are approximately 11 to 15 million cubic feet per day. We would be anxious to work with Congressional and interior staff to accomplish this task.
We believe that in-kind royalty is worth the consideration of any royalty owner that has the opportunity to take marketable volumes of oil or gas or has the opportunity to join with other royalty owners or producers in marketing significant volumes.
Mr. THORNBERRY. Thank you, Mr. Reid, and I failed to mention that without objection each of our full statements will be made part of the record. We will have a vote in just a moment, but for now we would like to continue, Mr. Darouse. I think we have certainly got time to have your statement in, and we will see how we get from there. We have got 15 minutes before we have to be over there.
STATEMENT OF DAVID DAROUSE, MINERAL REVENUE REGIONAL AUDITOR SUPERVISOR, DEPARTMENT OF NATURAL RESOURCES, BATON ROUGE, LOUISIANA
Mr. DAROUSE. Thank you, Madam Chairman, and good afternoon. My name is David Darouse. I work for Secretary Jack Caldwell at the Louisiana Department of Natural Resources. He is unable to attend today so I am here at his behest. The purpose of my testimony today is to explain and summarize our written testimony that we submitted earlier in the week and expound upon it and answer questions as time permits.
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It is obvious from our written testimony that we feel that in Louisiana, at least, there are certain legislative impediments that do not allow the state to take oil and gas in-kind and receive the maximum price that it could, and those are laid out in our written testimony.
But let us assume for discussion purposes that these impediments were not in the way and look at how a program would operate. There are certain things that we need, to have a successful take-in-kind program, and we also need to look at how success of such a program would be measured.
One thing that we need are large volumes of oil and gas concentrated geographically in one area so that we can move these volumes to an aggregation point at low expense, to where we can extract the maximum price possible by selling to third parties.
In the 8[g] area, unfortunately, Louisiana participates in about 35 or 40 leases that are spread out from the Louisiana-Texas border—literally laying on the border—all the way to the Louisiana-Mississippi border over in Chandeleur Sound.
Out of those 35 to 40 leases, we have really only 20 or 25 that are major-producing leases, and, again, they are spread out—not randomly—some are aggregated in certain areas—but more or less randomly across that strip of water. So we don't really have the concentrated geographic volumes that we can easily and inexpensively aggregate and move to a market and sell at a premium price.
But considering that we did have the concentrated volumes, which may occur some day, how should we measure the success of a potential take-in-kind program? One important criteria would be to measure the net revenues from a take-in-kind program against the existing royalty-in-value program that we have currently.
Net revenues would be defined as the gross revenues from a take-in-kind sale less the additional costs that will occur in getting that sale, and we have laid out a number of services: experts, forecasters, consultants, that we feel like we would have to have. Maybe not all of these but certainly some would have to be added to staff, either hired for the state to work for us or hired as contractors.
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Let us look at the current oil—not regulations—we don't have regulations in Louisiana—but how we are currently enforcing our oil leases in Louisiana. The program that we have in place is to value oil that is sold nonarm's length, not oil that independents or anybody sells to a third party, but oil that is sold nonarm's length to an affiliate or marketing arm of the producer, for value of that oil at what we call market price which we determine as either the Empire Louisiana spot price or the St. James Louisiana spot price, depending on whether we are looking at heavy oil or light oil.
Those prices are published by several major publications who survey those markets on a daily basis. The publications are well-known. Platt's Oilgram is one. Bloomberg's Oil Buyer's Guide is another. So in situations where the oil is sold nonarm's length, we are currently getting royalty-in-value or trying to get royalty-in-value by assessing those values against the values currently reported.
We are getting market value currently. We feel like on oil—like we are getting on oil or we are trying to get market value on oil. If we went to an in-kind program by taking oil in-kind, we feel like in the best situation, a competent marketer striking a competent deal on any given day can only get the price that we were getting currently at Empire and St. James. That doesn't even consider the additional marketing cost.
So we feel like oil take-in-kind would basically be a no-go for the state in the 8[g] zone or on state leases. On gas, we feel like an opportunity does exist for the state or the MMS to make money by marketing gas themselves. There are currently no spot prices across the country and specifically across Louisiana other than one location at the Henry Hub that gas value can be pegged to.
So in situations where we don't know what the value of natural gas is due to interaffiliate transfers, by taking gas in-kind and selling it and aggregating it on the open market, then that is a possible moneymaker for the state and we feel like also for the Federal Government.
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We commend the MMS for the past years of starting a pilot program back in 1994 which, although it was not revenue neutral, obtained many valuable lessons for the Minerals Management Service to apply in future take-in-kind programs.
We also applaud the MMS for having outreach programs over the last year where they have held meetings across the country soliciting input from various constituents such as states and industry. And we think they are heading in the right direction by realistically investigating potential R-I-K programs. And with that, I will conclude my comments.
[Prepared statement of Mr. Darouse may be found at end of hearing.]
Mr. THORNBERRY. Thank you, sir. I appreciate it. Mr. Magagna, we will go ahead and let you. I believe we have time to get your statement in if you would like to proceed in that way. When we come back, we can start with questions.
STATEMENT OF JIM MAGAGNA, DIRECTOR, OFFICE OF STATE LANDS AND INVESTMENTS, OFFICE OF FEDERAL LAND POLICY, STATE OF WYOMING
Mr. MAGAGNA. OK. Thank you, Mr. Chairman. I am Jim Magagna, Director of the Office of State Lands and Investments for the State of Wyoming. I want to take this opportunity to applaud the initiative of Chairman Cubin in providing this important dialog for the royalty-in-kind issue.
The State of Wyoming, under our Governor Jim Geringer, has assumed a leadership role, we believe, in seeking development and implementation of a cost-effective and efficient royalty-in-kind program providing an opportunity for full participation by affected states. We appreciate this opportunity to share our efforts and our expectations with members of the Subcommittee.
As I have indicated in my written testimony, part of Wyoming's initial effort to look at the option of a royalty-in-kind program certainly and admittedly has been driven by our frustrations with the current value based Federal royalty program. The Chairman earlier provided figures as to the tremendous amount of revenues and level of dependence that the State of Wyoming has on this.
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And since the initiation of net receipt sharing in 1991, we have been frustrated in our efforts to truly define what are the costs of administration that are being borne in part by the State of Wyoming through the deduct from our gross royalty revenues.
We were further frustrated when the Minerals Management Service announced a devolution proposal nearly 2 years ago and then quickly withdrew that proposal. We did work very closely with the Administration and with Congress in the development and passage of the Federal Oil and Gas Royalty Simplification and Fairness Act.
While we think it represented in many areas an important step forward, it was still very limiting from our perspective in the delegable functions which were recognized for the states. And it provided far greater secretarial discretion in delegation than we had hoped for. However, we do continue to work with Minerals Management Service in developing standards and guidelines for the implementation of this Act.
To comment only briefly on the valuation issue, we recognize and share concern that there are problems with the current system with valuation as it applies to non-arm's length transactions, and we applaud the Minerals Management Service for their efforts to address this. However, we feel that the attempt to impose a single index type figure based on the NYMEX or some simpler guideline does not apply to the situation that exists in Wyoming.
We have a unique situation here today with the completion of the Express Pipeline which will suddenly bring an additional 140 to 170,000 barrels of oil a day from Canada into Wyoming, some of which will stay in the Rocky Mountain region refineries.
What we have seen already in three short months of experience with that indicates that the impact of an activity like that on the market available to producers operating in Wyoming is very diverse from its impact on a national market as expressed by an index such as the NYMEX. We have seen some significant price declines in Wyoming as a result of this increased foreign supply that simply have not been reflected in the NYMEX or other standardized measurements to date.
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But Wyoming is driven every bit as much by the opportunities for revenue enhancement that we see in the royalty-in-kind program, and we recognize that with those opportunities comes risk. We as a state are prepared to assume those risks that are associated with the private sector in the marketplace and that are necessary if you are to achieve the rewards that can be associated with that.
As a first important step in this direction, the 1997 session of the Wyoming Legislature passed legislation authorizing the Governor to take the state's share of Federal mineral royalties in-kind should Federal law and policy so permit. This was a strong statement by our legislature of their desire to have the state move in this direction.
In followup to this, as a part of the Minerals Management Service's effort to look at possible pilot projects, Wyoming has offered a pilot project to the Minerals Management Service. We are appreciative of their efforts in working with us.
However, I would offer one note of caution. While we believe that there is value in a pilot process in order to test a methodology for a royalty-in-kind program. Due to the inability to aggregate large volumes and reduce administrative costs in a pilot program, we feel it should not be looked upon as a test of the net ability to enhance revenues as a result of royalty-in-kind.
I would like to move on and quickly focus on some of the key elements that the State of Wyoming believes are critical in a Federal royalty-in-kind program in order to allow full participation by the states. The first and most important of these would be that the state would have an absolute right which it could exercise to receive at or near the lease its 50 percent gross share of Federal royalty oil and gas.
We would further encourage that the states be given an opportunity, or a preference I might say, to also acquire and market on the Federal Government's behalf the Federal 50 percent share provided that the net return to the Federal Government would not be reduced thereby.
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Because it has clearly been shown that there are advantages to aggregation through the market strength that comes with larger volumes, allowing the state to potentially handle 100 percent of the royalty volume would be a step in the right direction.
We do think it is important in a royalty-in-kind program that the state be entitled to the full 50 percent of its gross share of Federal mineral royalties, and that the state then bear the marketing costs, the state bear the risks associated therewith, but not be put in a position of having to bear the Federal administrative costs, which we would hope would be dramatically reduced as a result of a royalty-in-kind program. I am aware of several additional principles that the industry has developed, and we would be supportive of these.
Finally, let me say that a royalty-in-kind program is not a simple step forward. I believe it does involve a major reengineering of the current approach to royalty receipt. We have had the opportunity to personally view the program in operation in Alberta, Canada. While their situation is very different, we believe that their program as it currently operates would provide a good starting point for the development of a Federal program in the states.
But I would emphasize in closing the importance that we see in the development of a program that this be done as a joint effort involving the Minerals Management Service, the affected states, and the industry on an equal footing basis. What comes out of this would be something that there is a comfort level with that it will work for all of the various interests. Again, I want to take this opportunity to thank you for being able to appear before the committee today.
[Prepared statement of Mr. Magagna may be found at end of hearing.]
Mr. THORNBERRY. Well, thank you and I appreciate all of the testimony of each of you gentlemen. We are going to have to go vote. We have a few minutes of debate and then the vote on the tax bill. I just want to make one comment before we do that. As some of you may know, I introduced a royalty-in-kind bill last Congress. Anybody who suggests that that was an effort by the oil and gas companies was not around because that was certainly not the case. They were less than enthusiastic about that idea.
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The motivation is what it can mean for the taxpayers, and those are the ones that I think really have some to benefit, as well as the states. And we have a lot to learn from what is going on in your states, what is going on in Alberta, the input of the industry, and the very valuable input that MMS is gaining in their meetings across the country.
And I want to get that input because my plan in September is to introduce another royalty-in-kind bill because I think it is important to push this idea forward, to have something to talk about, and I want to see this move forward for the taxpayers and for everyone. And so that is the kind of input that we will look forward to. We will recess temporarily as we go vote.
[Recess.]
Mrs. CUBIN. [presiding] Please pardon me for having to be gone. I had a bill that I am the sponsor of being marked up in another committee. And then, as you know, for the first time in 16 years we just voted a tax cut for middle class Americans and all Americans. And we are really happy to have done that. I think I will let Mr. Brady question the panel to begin.
Mr. BRADY. Thank you, Madam Chairman, very much. I appreciate the panel, first, your testimony and, second, the patience you have for us to go vote today. I guess for Mr. Reid, because I am from Texas and pleased with how the system works, as a member of the legislature I have supported some of the changes to make that program more efficient, more effective as you learn how to do it well and better. And we are very pleased with the results.
Two thoughts: one, I am impressed with the efficiency of the Texas R-I-K program versus the current Federal in-value system on the basis of employees. And could you at some time provide to the Subcommittee a table showing the staff-to-volume ratio in Texas for both your oil and your gas programs?
Mr. REID. I would be happy to.
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Mr. BRADY. And, second, do you have any suggestions on how the Texas program could be expanded to a Federal program?
Mr. REID. If I understand your question, one of the issues with the Texas program, of course, is so much of the benefits we receive there come from the agency end-use program. Obviously, the Federal Government is a major consumer of gas, and there might be a potential for a similar program at the Federal level.
As far as our experience on our in-kind, our spot sales say of gas or oil sales, the issue in Texas—we do have a situation where we have enough quantities—volumes in enough concentration for it to work. I mean, there may be selected areas where MMS may have the ability to do that.
Our spot sales do not generate the spread that our agency sales do in terms of our enhancement. When you look at our total enhancement, they are probably less than 5 percent of it. But in terms of how it works, I mean, we handle it in-house. We are looking at a private marketing firm to do it.
And in Texas it is really a cost benefit analysis. If we make more money doing it the other way, we will do it. If we don't make more money for the school fund, we won't. And we do a cost benefit analysis periodically on our gas program and on every oil sale to see whether we are really generating more revenue for the school fund than we would have received as a royalty payment.
Mr. BRADY. So it is in the State of Texas program. Rather than using state resources passively to regulate and audit, you use it actively to get the most value for those in-kind products that you receive. Is that correct?
Mr. REID. Right.
Mr. BRADY. Thank you very much for your testimony. I appreciate it. And the representative from Louisiana, a question for you. Do you have an assessment or have you done an assessment of the cost savings of shifting your current audit staff and litigation expenses you have into a marketing type of program? Have you had an opportunity to take a look at that type of change?
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Mr. DAROUSE. No, sir, we have not.
Mr. BRADY. Is your program a bit—in your opinion, has it been restrictive in its criteria as you have tried to enter the market and look at the oil side of it or the gas side of it? Do you feel like there are improvements in the Louisiana program that could allow you to make it more effective?
Mr. DAROUSE. Our written comment addressed that. We think that if there are certain changes made legislatively, and if conditions change, that it would be beneficial to market our gas in-kind. Right now there just seems to be a consensus that there are some prohibitions against doing this effectively. I know back in 1985 or 1986 we considered a program similar to where Texas ended up and that would be taking state gas in-kind and sending it to institutions, and it never really got off of the ground.
Mr. BRADY. But that would be an implementation that could assist the cost benefit part of the program for the State of Louisiana and could generate more——
Mr. DAROUSE. Yes, sir. To a certain extent, yes, sir.
Mr. BRADY. Great. Thank you. Thank you, Madam Chairman.
Mrs. CUBIN. I want to welcome you, Mr. Magagna. Everyone knows you are from my great State of Wyoming, and thank you for your testimony. As usual, you always do a yeoman's job for the state, for the Governor, and for me as well. And I want to thank you for that.
While I wasn't here to hear your testimony, I did read everyone's testimony before the hearing so I do have an idea of what all your feelings are. But, Jim, your testimony about R-I-K was quite specific on what you believe will be necessary for a success.
And one of the things that you stated in your testimony was the states must have the right to receive 50 percent of the gross share in-kind. Does that mean that it would be entirely unacceptable to Wyoming to adopt to a R-I-K program like they have in Alberta where private marketers would sell all of the mineral?
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Mr. MAGAGNA. Madam Chairman, no, not at all. In fact, we believe that the appropriate way for a program to operate would be for the state to contract with private marketers to market the state's royalty share. All I mean to say by that is that we should receive 50 percent of the gross without any obligation to any deduction therefrom back to the Federal Government.
Mrs. CUBIN. I am not sure and so I hope someone will correct me if I am wrong about this, but I think that in Alberta they market all of the mineral so that I think the way it would be is that a marketer would sell the Federal share and the state share together and then divide the money. Is that right?
Mr. MAGAGNA. All of it.
Mrs. CUBIN. Right, right. But, anyway, that would be the method, and is that an acceptable arrangement do you think for the State of Wyoming?
Mr. MAGAGNA. That the marketer would share——
Mrs. CUBIN. Would sell the Federal share and state share and then the money be divided after the sale.
Mr. MAGAGNA. That would be dependent on who negotiates that marketing contract. It is our belief that the state should be given the opportunity at least as to the state's 50 percent gross of the royalty mineral to arrange for that marketing; in other words, to determine what the terms and conditions would be, to accept those risks associated with the marketplace, even though we would market through a third party marketer.
We would not be comfortable with a situation that simply allowed the Federal Government to market 100 percent of the royalty share as they saw fit with the state simply being the recipient of a check for half of that amount.
Mrs. CUBIN. So then would it be acceptable for Wyoming to be the marketer for all of the mineral and then divide the money and then give the Federal Government their share?
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Mr. MAGAGNA. We would certainly find that acceptable, and we would anticipate if that were done and would be willing to accept that there would have to be some criteria in order to assure that the state, in fact, would not be getting less for the mineral than what the Federal Government might be capable of getting. With those parameters, certainly.
Mrs. CUBIN. I agree with you and your statement that de minimus-producing wells could really present a problem with R-I-K. However, as the provisions of the Royalty Fairness Act became implemented which would allow once a year royalty payments or a buyout of royalty obligations by lessors once a year with de minimus production, perhaps there would be room to consider how to take R-I-K for stripper wells. Do you have any thoughts on the cutoff production level for de minimus?
Mr. MAGAGNA. I really would not be prepared today to recommend a particular cutoff level. But when you combine the provisions in the Royalty Fairness Act authorizing the annual payment or the buyout with a royalty-in-kind program, we would be hopeful as you put those together you would be able to thereby eliminate the need for a continuation of a valuation based royalty system because that could be picked up through the specific provisions of the Fairness Act.
Mrs. CUBIN. My time is up and because we have already been interrupted with the vote and whatnot, with your permission, I would like to submit some written questions to you, and then we can move on to the next panel. Thank you very much for your testimony. And would the second panel please come forward? Thank you very much.
I would like to introduce the second panel that is with us today; Mr. Larry Nichols, who is the President of Devon Energy; Fred Hagemeyer, the Coordinating Manager, Royalty Affairs for Marathon Oil Company; Sue Ann Hamm, Vice President of Oil Marketing and Sales for Continental Resources; and Edmund Segner, III, Executive Vice President and Chief of Staff for Enron.
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I would like to remind the witnesses that under our Committee rules that the testimony must be limited to 5 minutes, and certainly your entire testimony will appear in the record. So the Chair now recognizes Mr. Nichols for his testimony.
STATEMENT OF LARRY NICHOLS, PRESIDENT, DEVON ENERGY
Mr. NICHOLS. Well, thank you, Madam Chairman. I am Larry Nichols, President and CEO of Devon Energy Corporation, an independent producer who has Federal onshore production. I am here today on behalf of Devon and 13 oil and gas associations who represent most of the payers of Federal oil and gas royalty payments.
For the purpose of the hearing today, I will summarize my comments but ask that the entire written statement be included in the record, as well as this statement which reflects all of the trade associations who are endorsing my statement today.
Madam Chairman, we always appreciate the opportunity to work with you in pursuit of a more simple, a more certain, and a more efficient program for collecting royalties due to the Treasury and the states from Federal oil and gas production.
As each year passes, the need to reengineer the royalty collection system dramatically increases. With each new valuation rulemaking effort, more and more complexity and more uncertainly is added to the royalty collection system. Instead of accepting a producer's wellhead values, elaborate netback schemes are now being developed that will only result in more and more disputes.
All of the agencies' concerns and perceived problems over how to value royalty can be addressed by a royalty-in-kind program. As a consultant, who is regularly used by the MMS, stated in a report to the states, ''The only way to be absolutely certain that a fair market value is received for royalty oil is to take the oil in-kind for sale.'' We agree that royalty-in-kind accurately measures value by capturing all the value resulting from a transaction between a willing buyer and a willing seller at or near the lease.
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There has been much theorizing about the benefits and drawbacks of royalty-in-kind. It is time to bring royalty-in-kind to the drawing table, to build a successful royalty-in-kind program, and once and for all to bring to an end years and years of disputes and debate about royalty payments.
This hearing today brings royalty-in-kind into focus as an exciting reengineering opportunity for both the government and the industry. I would like to tell this committee what the industry is doing to bring royalty-in-kind into reality. First, industry participated in a series of workshops that the MMS held this year in response to their fiscal year 1997 appropriations which asked them to pursue additional royalty-in-kind pilot programs.
At these workshops, the MMS heard a consistent message from the oil and gas industry—yes, we are without a doubt interested in designing a royalty-in-kind program which would result in a more simple and certain royalty collection system.
During these workshops, the industry agreed to outline for the MMS and the states the goals, principles, and design elements of a successful royalty-in-kind program. To initiate this progress, representatives from oil and gas associations from across the country formed a royalty-in-kind workgroup. I am glad to report to the committee that this workgroup has developed an in-kind mission statement and a common set of principles for designing a successful royalty-in-kind program.
The mission statement and principles I am about to describe are supported by the Independent Petroleum Association of America, the Domestic Petroleum Council, the California Independent Petroleum Association, Colorado Oil and Gas Association, Independent Petroleum Association of Mountain States, Independent Petroleum Association of New Mexico, Louisiana Independent Association, Mid-Continent Oil and Gas Association, National Oil Industries Association, New Mexico Oil and Gas Association, Oklahoma Independent Petroleum Association, Petroleum Association of Wyoming, and the Rocky Mountain Oil and Gas Association.
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This is a work in progress for all of us. Many critical implementing details need to be developed and discussed among these groups before moving beyond support for these principles. The agreed-to mission statement for a royalty-in-kind effort is to design a royalty-in-kind program that will eliminate valuation uncertainty and will be attractive to the Federal Government, the state governments, and the private sector stakeholders, while recognizing the differences between oil and gas production.
The six agreed-to royalty-in-kind principles are as follows: one, reduce the administrative and compliance burdens while providing the opportunity for Federal and state governments to maximize their revenues. This principle is intended to make sure that a royalty-in-kind program does not move forward unless it is a win-win for the Federal Government, state governments, and the producers.
Two, require transactions to be at or near the lease as required by the lease obligations. Three, provide that when the government takes in-kind it must take all royalty production for a time certain. Four, require use of private marketing expertise to streamline government operations.
We have heard some comments earlier today that expressed concern, with which we agree, that this plan might require the government to get into the business. That is not the case at all. Just as the Federal Government can build buildings without becoming a building contractor and just as the Federal Government can construct highways without becoming a highway constructor and getting into that business, so can the Federal Government market their oil and gas business without getting into that business.
Five, provide the states with the opportunity to be involved in designing and implementing the program. And, finally, six, to make sure that royalty-in-kind programs are broadly available for public purpose. As I just stated, there are a number of design issues that need to be worked out to determine the success of the royalty-in-kind program. We believe that issues such as transportation, aggregation processing, and other matters need to be resolved and look forward to working on that in the future.
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This is the time when we need to make certain that we can work together as a cooperative effort. We are concerned with the manner in which the MMS has qualified revenue losses in its gas in-kind experiment. We think those mislead people into believing that a successful in-kind program cannot be implemented.
And, second, and most importantly, we want to make sure—is the concern that a royalty-in-kind program be revenue neutral. Let us not forget that the real value of a royalty-in-kind program is to save the tremendous administrative costs that are currently being incurred by the Federal Government, the states, and the industries.
Before the MMS moves forward with a royalty-in-kind program, we need to make sure that a royalty-in-kind program can adhere to the six principles that I discussed above. Thank you very much, Madam Chairman.
[Statement of Mr. Nichols may be found at end of hearing.]
[List may be found at end of hearing.]
Mrs. CUBIN. Thank you, Mr. Nichols. Mr. Hagemeyer, would you please give——
STATEMENT OF FRED HAGEMEYER, COORDINATING MANAGER, ROYALTY AFFAIRS, MARATHON OIL COMPANY
Mr. HAGEMEYER. Sure. I would be happy to. Thank you, Madam Chairman, members of the committee. I am Fred Hagemeyer and I am pleased to be here this afternoon representing Marathon Oil Company. There are several oil and gas associations that have endorsed my written comments, and I would like to introduce those into the record if I may.
Marathon is a fully integrated oil and gas company involved in worldwide exploration, production, transportation, and marketing of crude oil and natural gas. Marathon holds leases both onshore and offshore. In 1996, Marathon paid royalties of over $84 million for oil and natural gas produced from Federal and Indian lands. In addition to the royalty paid in cash, the Minerals Management Service took crude oil valued at over $9 million in-kind through the small refiner royalty-in-kind program.
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We are here today to discuss royalty-in-kind as an alternative method for satisfying the royalty obligations of producers with Federal oil and gas leases. Public workshops were held this spring to discuss and review possible options for a major royalty-in-kind program. Marathon actively participated in these sessions and welcomed the opportunity to candidly discuss critical features of a workable R-I-K program.
At Marathon, we have learned that reengineering an entrenched process is not easy. But if all stakeholders are engaged in the process and it is done properly, the results can be significant. Many times the benefits are much greater than anticipated because it is difficult to identify all the indirect benefits. As part of the MMS reengineering effort, Marathon believes that a R-I-K program can be created which will fundamentally add value to the MMS royalty process.
Royalty-in-kind is a concept whose time has come. The key is turning this opportunity into reality. By taking its royalty oil or gas in-kind, the MMS has the opportunity to aggregate volumes, determine the most favorable sales locations, arrange transportation, and negotiate the terms and conditions of the sale of its royalty production.
Participation in these activities can result in optimized value if the MMS manages the risks and costs associated with the marketing function. Expertise of a competitive private marketer would allow the MMS to participate in these activities in the most efficient manner possible and thus achieve the greatest possible revenue benefits. The administrative burdens of both the MMS and the Federal lessees, especially the audit and litigation costs, would be reduced significantly or even eliminated.
As Larry Nichols mentioned, a multi-association task force has been recently formed to develop a workable Federal royalty-in-kind program. Marathon is an active participant in this task force. Marathon would welcome and does welcome the certainty of knowing its royalty obligation was fulfilled once the royalty barrels were delivered to the MMS.
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And Marathon recognizes that expertise in all segments of the oil and gas business will be necessary to develop a Federal royalty-in-kind program that is both viable and workable. It seems that the Subcommittee can benefit tremendously from the efforts of this task force. This process is not easy, but we feel it is vitally important in developing a successful program.
An important step in this process is to look at examples of existing R-I-K programs—the Texas GLO program, which you heard about earlier, takes all of its royalty all in-kind from the Marathon-operated Yates field, one of the largest onshore oil fields in the United States. Overall, Marathon's experience with the Texas royalty-in-kind programs has been positive.
One of the lessons that we have learned from the Texas R-I-K program is that any new comprehensive program is going to experience startup problems. During the first year of the Texas programs, there were problems concerning which party was responsible for gathering costs, the arrangement and verification of transportation, and the proper allocation of production.
However, over time, producers, the purchasers, and the state have been able to work through these problems. And for this reason the MMS must be very careful if it chooses to implement and evaluate any royalty-in-kind pilot program. In fact, Marathon believes it may be more prudent to expend this effort in developing a permanent R-I-K program that could be phased in over time.
Marathon is concerned at the impact of a royalty-in-kind program on the Federal and state treasuries, that it be analyzed properly. API recently completed an assessment of the MMS review of the 1995 Royalty Gas Marketing Pilot Program. Attached to my testimony is the API report which raises a number of issues for the underlying validity of the revenue assumptions and the cost analysis of the pilot. The concerns raised by API should be addressed.
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In summary, I would like to say that Marathon believes the time has come for the Federal Government and the oil and gas industry to seriously consider royalty-in-kind as the best long-term solution to satisfying the Federal lessees' royalty obligation. A properly developed R-I-K program could streamline the royalty process for the Federal and the state governments and the oil and gas industry.
Working together, we can minimize many of the startup problems which may occur and shorten the learning curve for both the Federal Government and the lessees. A royalty-in-kind program can be a win-win proposition for all the parties involved. Thank you very much.
[Prepared statement of Mr. Hagemeyer may be found at end of hearing.]
[List may be found at end of hearing.]
Mrs. CUBIN. Thank you very much. The vote that is being held now is a vote to adjourn, and I think I will just let them decide that without me so that we can get this hearing moving along. Ms. Hamm, would you please give us your testimony now?
STATEMENT OF SUE ANN HAMM, VICE PRESIDENT, OIL MARKETING/SALES, CONTINENTAL RESOURCES, INCORPORATED
Ms. HAMM. Thank you, Madam Chairman. I am Sue Hamm, and I am Vice President of Crude Oil Marketing for Continental Resources. And I am here on behalf of Continental, IPAA, OIPA, and the RMOGA, Rocky Mountain Oil and Gas Association, and they are all endorsing my written——
Mrs. CUBIN. Excuse me. Could I get you to pull the microphone a little closer?
Ms. HAMM. Oh, I am sorry.
Mrs. CUBIN. Thank you.
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Ms. HAMM. And I would like to submit that for the record. And Continental Resources is a small, privately held independent producer who has Federal onshore production. And I am not going to go into everything