DOI’s lease sales out of sync with market
The U.S. Department of the Interior (DOI) lacks a formal process for assessing the adequacy of its fiscal system—a phrase that covers the rents, royalties, and other payments companies hand over to the federal government for the right to extract and sell oil and gas (O&G) from federal onshore and offshore lands.
The lack of “documented procedures” to determine if the DOI is receiving payments that are comparable to what other nations and U.S. states collect from energy companies has cast doubt on whether the American people are getting a “fair return” from companies that are profiting from public resources. The problem has been acknowledged without a word of protest from the DOI, which recently announced that it would take measures, including rulemaking, to improve the onshore and offshore fiscal system.
Concerns about how much energy companies pay for onshore and offshore leases have been around at least since the early 1980s when a federal task force made 60 recommendations for improving the fiscal accountability of the nation’s onshore and offshore resources. In March 1983, the DOI announced that it would refine the fiscal system to ensure that the American people receive a full and fair return from the development of their resources. But in 2007, the Government Accountability Office (GAO) found that the U.S. government receives one of the lowest government takes—the total revenue as a percentage of the value of oil and natural gas produced—in the world.
In addition, in September 2008, the GAO said the DOI did not routinely evaluate the federal O&G fiscal system and suggested that Congress consider directing the DOI to convene an independent panel to conduct a comprehensive review of the O&G fiscal system and also establish procedures to periodically evaluate the state of the fiscal system.
DOI’s efforts to improve the fiscal system did little to assuage GAO’s concerns. Consequently, in 2011, the GAO added DOI’s management of federal O&G resources to GAO’s list of programs at high risk of fraud, waste, abuse, and mismanagement. The fiscal system listing remains on the 2013 high-risk list, one of only three natural resources/environment programs on the listing. (The two others are the government’s fiscal exposure caused by climate change and assessing and limiting exposure to toxic chemicals under the Toxic Substances Control Act.)
Now in a new report on the fiscal system, the GAO states that the DOI has taken some steps to improve the royalty rates for offshore development but has not changed onshore terms. The report ends with three recommendations intended to improve DOI’s ability to better manage its fiscal system and adjust royalty rates in light of revenues from O&G development collected by other resource owners. In a brief letter responding to the report, Rhea Suh, DOI’s assistant secretary for Policy, Management, and Budget, expressed “general agreement” with each of the recommendations and stated that corrective actions will be taken.
Incentives to develop
The regulation of U.S. onshore and offshore resources is assigned to the DOI under two statutes, both of which are written to compel the department to encourage companies to rapidly develop resources on public land, pay royalties, and make other appropriate payments to the American people. Provisions of the Outer Continental Shelf (OCS) Lands Act are intended to ensure the public “a fair and equitable return” on O&G resources developed offshore. Also, the DOI relies on the competitive leasing process required by the Mineral Leasing Act to ensure fair market value for onshore O&G resources.
The GAO notes that because the revenues these leases generate depend on the amounts of oil and natural gas that companies produce from them, the federal government has designed the fiscal system to balance the goal of providing a fair return with sufficient financial incentives for companies to commit resources to exploring, developing, and producing O&G from their leases.
The fiscal system does work. The DOI reported that domestic and foreign companies received over $66 billion from the sale of O&G produced from federal lands and the OCS in 2012. About $9.7 billion from royalties and other payments were taken in by the DOI from these companies, making O&G resources one of the federal government’s largest nontax sources of revenue. In addition to the collection of these payments, the federal government assesses taxes on the profits companies earn on the sale of O&G produced from federal leases.
But in its September 2008 report, the GAO found that the DOI had a lower government take for O&G production in the Gulf of Mexico than all but 11 of 104 O&G resource owners, which included other countries and some U.S. states. The GAO also found that the DOI did not routinely evaluate the fiscal system, monitor what other governments or resource owners were receiving for their resources, or evaluate and compare the attractiveness of federal lands and waters for investment.
50 percent Gulf hike
In light of such criticisms, the DOI took some steps to ensure a fair return. For example, in 2007, the department increased the royalty rate from 12.5 percent to 16.67 percent for new leases in water depths greater than 400 meters in the Gulf of Mexico. In 2008, the DOI increased the rate again for all Gulf of Mexico leases to 18.75 percent, which remains the current rate. (The current lease rate of 12.5 percent for the OCS of Alaska has been in place for about 30 years.)
According to the GAO, the DOI said the incremental increases were instituted in response to a variety of factors, including higher O&G prices; improvements in deepwater exploration and production technologies; and the competitive market for offshore leases. The DOI estimated that the royalty rate increase from 16.67 percent to 18.75 percent would result in a net increase of $4.3 billion in the total Gulf of Mexico federal revenues from bonuses, rents, and royalties from new leases, a 5 percent increase from $87.4 billion to $91.7 billion over 30 years.
In addition, the DOI established escalating rental rates—rates that increase over the duration of the lease—to encourage faster exploration and development of leases, or earlier relinquishment when exploration is unlikely to be undertaken by the lessee. Neither of these actions has dampened the sales of leases. The GAO found that after the 2008 royalty rate increase, demand remained high for newly offered leases in the Gulf of Mexico, and the DOI reported strong bidding interest in the three subsequent lease sales.
Onshore rate stagnant
The situation differs for DOI’s onshore areas, which currently can be leased at 12.5 percent, a royalty rate that has remained unchanged since the 1980s. DOI officials have been considering changing this rate through rulemaking, reports the GAO. That consideration was motivated in part by a call from the federal Office of Management and Budget to increase onshore royalties because of GAO’s recommendations. The DOI responded that it began rulemaking to amend the current onshore rates, which are written into regulations. But the process was discontinued because, the GAO said, the DOI lacked enough information to determine how royalty rates should be revised to better ensure a fair return to the public.
DOI officials also told the GAO that they plan to ask for public comments on the types of royalty rate structures that should be considered, such as whether DOI’s Bureau of Land Management (BLM) should develop a uniform rate for all onshore leases or different rates by region, state, geologic formation, or resource type. Furthermore, the DOI said it plans to ask for comments on whether sliding scale royalty rates, which vary with the price of the commodity, might be appropriate in specific circumstances. The DOI added that an advance notice of proposed rulemaking (ANPR) is under development, but work has been limited by higher priority rulemaking, such as regulations for hydraulic fracturing and revisions to O&G measurement regulations.
The GAO also reports that the DOI is examining potential regulatory changes that could simplify royalty payments and collections. The GAO previously reported that the existing valuation regulations are complex and can result in inaccurate royalty payments by industry; this could increase DOI’s costs to ensure accurate payments because detailed and time-consuming audits of records may be needed. In May 2011, the DOI published an ANPR requesting comments to inform potential changes to regulations intended to simplify royalty payments and collections.
The GAO says that others who have reviewed the royalty system have identified numerous shortcomings in DOI’s royalty collection programs, resulting in complex requirements for calculating the value of O&G and associated deductions and allowances for activities such as transportation. The ANPR is intended to provide greater simplicity, certainty, clarity, and consistency in production valuation; decrease DOI’s costs to ensure compliance; decrease industry’s compliance costs; and provide more certainty to the DOI and industry that companies “pay every dollar due to the government,” says the GAO.
Documented procedures
Finally, the GAO was particularly concerned that the DOI has no documented procedures in place for determining when to periodically conduct assessment of the fiscal system as a whole. Apparently, DOI’s recent issuance of a contract to conduct such an assessment was the first in over 25 years. “Without documented procedures, Interior cannot ensure that it will consistently conduct such assessments in the future, and without periodically conducting such assessments, Interior cannot know whether there is a proper balance between the attractiveness of federal leases for investment and appropriate returns for federal oil and gas resources, limiting Interior’s ability to ensure a fair return on federal oil and gas resources,” says the GAO.
In response to a draft of GAO’s report, Assistant Secretary Rao stated the following:
- The BLM, the DOI division in charge of onshore leases, will move forward with a rulemaking to revise its existing regulations to provide the DOI with broad flexibility in setting onshore royalty rates.
- DOI’s Bureau of Ocean Energy Management (BOEM), the DOI division overseeing offshore leases, and the BLM will periodically examine the need for conducting updated assessments of the fiscal system. Factors to be considered in the assessments could include consideration of the extent of recent changes in market conditions, resource prices, new discoveries, technological advances, and the portion of economic rents captured by the federal government.
- The BOEM proposes to document the procedures it will follow for analyzing fiscal terms for individual lease sales under prevailing and expected future market conditions.
Oil and Gas Resources: Actions Needed for Interior to Better Ensure a Fair Return.
William C. Schillaci
BSchillaci@blr.com