Hearing of the Energy and Mineral Resources Subcommittee of the House Natural Resources - Getting Royalties Right: Recent Recommendations for Improving the Federal Oil and Gas Royalty System
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REP. STEVE PEARCE (R-NM): Thank you, Mr. Chairman. The hearing today we've titled, "Getting Royalties Right." If I recall, last year I recall that royalty is at risk, and I would say that as we get into the hearing I'd like to pause because the misperceptions that are being created is that they are lost for all of these when real royalties are being lost because of the energy policies that are originating from San Francisco type energy policies.
My question is when is the subcommittee going to get royalties right. The dollar value is falling; our economy is slowing, the price of WTI oil yesterday closed at a record $107.87 per barrel. The spot price for natural gas closed at $9.58 per TCF. The EIA is expected to forecast record-high gasoline prices for the summer. There's an outcry for supply, but that outcry is falling on deaf ears.
This country keeps its potential revenue from royalties and energy supply off limits. The majority keeps it off limits by creating a misperception that we drill everywhere, and all of the time of the 262 million acres of BLM land, less than 5 percent to that land is being used for oil and gas production. The other 95 percent of BLM lands has oil and gas -- has no oil and gas production.
The resources are there, we just don't produce it, and so when we talk about the lack of stewardship for the American people we shouldn't look in the mirror. Simply -- similarly, only 15 percent of the national wildlife refuge systems has oil and gas activities.
Furthermore, and not a drop, 0 percent of our power plants permit oil and gas activities. We learned last Congress that less than 3 percent of our outer continental shelf is being leased for oil and gas production, and this at a time when we are raising -- we are seeing prices of gasoline moving towards $4 a gallon.
The majority keeps it off, keeps production off limits by convincing the American people that we don't have enough energy here in the U.S. To keep up -- (inaudible) -- they cut off 2 trillion barrels of shale oil in Colorado last year, Colorado and Utah last year, in our omnibus spending package; 2 trillion barrels that's double all of the world's oil.
Endless royalties are being now bypassed because of a decision made by this Congress. These are the royalties at risk if we continue to follow these democratic energy policies they will continue to be at risk. This hearing is a classic example of penny wise pound foolish. There are billions of dollars of federal royalties left on the table because more and more of our federal lands, where much of the energy is, remains off limits.
And I am looking forward to the testimony. For instance, Mr. Devaney says in his comments that foreign investigations remain ongoing. I am going to ask Mr. Devaney, and I hope he deals with the question upfront, what the Justice Department is telling him about those investigations because I am concerned that if the Justice Department doesn't see his reasons for continuing investigations, I am concerned why we are doing those investigations.
Also Mr. Rusco, I am interested in your GAO report, you state that the Interior lacks adequate assurance that is received in full compensation for oil and gas produced in federal lands. And yet, when I read this comprehensive report with multiple qualified people on the panel, that put that report together, I see that the MMS is an affective steward of the Mineral's revenues. There's no middle ground between those statements, they are diametrically opposed.
And I am looking forward to the testimony and it's going to assure me that the GAO actually used the same kind of qualified people that I can find on the list here. And so I will be asking about that in your testimony, how can we come to diametrically opposed opinions from two different oversight agencies?
So I am looking forward to the testimony today. And I do, Mr. Chairman, I am aware of the criticism of Royalties-in-Kind. Royalties-in-Kind, everyday the price of oil is different in a different piece of the country. Price of oil is depending on the quality, of the amount that it's going to cost to produce it. And we have to figure out every single area under every single price in the country to see if we get our dollars (ph) and yet if we simply did our RIK, Royalty-in-Kind we simply say you made that many barrels, we get a percent, and we'll take it here, we'll take it there.
And similarly on gas you just read a meter, you don't have to do the complex calculations with lawyers and auditors in the way that we are processing right now, the non-Royalty-in-Kind process attracts lawyers and auditors like sharks to blood.
Again, I look forward to the testimony and discussion today; I'd just ask that all things be put in perspective. Welcome to you all, I appreciate your coming here for your testimony, and we look forward to it, thank you Mr. Chairman.
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REP. PEARCE: Thank you, Mr. Chairman. And "poised" is never the word that I find used with me much -- "unpoised," maybe.
Mr. Rusco, the -- if you remember the conversation in our office, we were talking about government take and report that is coming up, and I talked about the tendency of your reports coming from your office to maybe use hyperbole. And so if I get you to hold or get my staff to hold up, the government take is very -- in your views is quite more simplistic.
But this is -- government take in Russia is definitely higher than it is here. But you can't give a moral equivalence between the Russia system that allows this kind of thing to go on in our country where these cleanups occur. So I find your -- that's okay, put it down, it's distracting even me.
But the -- you draw rather harsh conclusions, I think in your report. And one of the things that you're critical of is that relies heavily on self reporting. That's a curious thing, because what we did in -- as just compared to IRS -- and we even have IRS people here -- and if I'm not mistaken, IRS depends on self reporting.
And so we find it okay with the mass of the public. And I find -- always I'm curious when people find other people's behavior suspicious, and their own behavior above reproach. So when we say that the weakness of the system is self reporting, I don't find in your report that you -- where you mentioned that we actually conduct 8.2 percent where we exactly -- MMS examine 8.2 percent of the properties and 25.9 percent of the payers. IRS only looks at 1 percent.
And I wonder if you had an IRS person on your team because the other -- this big report that comes from Mr. Deal's committee -- now, there were two senators on that. And by the way, I find people from state -- treasurers, professor of finance, deputy assistant director of MMS, of Bureau of Land Management, economists, and I wonder if you had this panel that were led by two of the senators to see that maybe this report came out with less hyperbole and more facts as our -- we were looking at a very complex thing here.
I wonder I didn't see any list of people, and I had asked for that in my opening statement. I would hope that you would provide that for us to some point. Now, you are quick to say that the methodology that is calculating financial benefit is not good. And I wonder in your own methodology the -- there is an independent accountant report that says methodology is raised when inaccurate. In your report, did you consider these outside sources?
MR. RUSCO: Yes, we did.
REP. PEARCE: You did? And so we have this report that says it is accurate and your report says it's inaccurate. And I wonder what specialists -- how many weeks did you spend on your report versus this report here?
MR. RUSCO: We began auditing -- well, we've been auditing MMS on and off for years, but this particular job we've been at for about a year. On our team we have economists, accountants, data analysts, specialists, IT auditor, license IT auditors, oil and gas geologists, engineers, and general auditor staff --
REP. PEARCE: So your report considers this, but says that this finding was inaccurate. We got independent accountants who find that it's okay, and your team says it's not okay and you were working for a year. Now, I've got the KPMG. KPMG is one of the big three if you're going to get somebody to be an accountant.
KPMG for three years -- three years says we noted no deficiencies involving design of the internal control over the existence, completeness, assertions related to any key performance measures. And yet, you find the lack of key internal controls, you spend a year on your report. Was this generally a report you were working on during the year?
MR. RUSCO: No.
REP. PEARCE: How many reports were you working on during this year, period?
MR. RUSCO: Personally, I've probably worked on seven or eight, but the team --
REP. PEARCE: Okay, so you've got seven or eight, so we can say that roughly may be two months, two months' dedicated time unless you're working overtime --
MR. RUSCO: That would be my personal time.
REP. PEARCE: -- and I'm sure you did. But again, we go back to the KPMG reports, find no deficiencies, and you find -- you find that there are lack of key internal controls.
And I wonder at the discontinuity, I wonder if the hyperbole that we found -- lift that chart up over here one more time -- if the hyperbole and simplicity of what you've done is the same simplicity that said we collect fewer royalties than Russia and yet that's Russia, that's an oil lake that exist, and your committee did not -- your findings did not include any of that.
And I wonder why you came up with different substantive findings than people who audited three years. Two different major accounting reports that found exactly the opposite of what you found.
Mr. Chairman, I will come back in a different -- in my next round.
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REP. PEARCE: Thank you.
Mr. Deal, do the oil companies fill out any reports every year about how much production that they make and then how much they give? Are there any reports that are filed?
MR. DEAL: Well, there are all kinds of annual reports, but on a regular basis they have to submit every month -- (cross talk.)
REP. PEARCE: They have to submit something?
MR. DEAL: Yes.
REP. PEARCE: So when Mr. Rusco says there is a contrast between what IRS does and what MMS does, IRS demands a W2 from every filer. And if I understand your testimony correctly, the oil companies have to turn in some similar documents saying we produced this much and we pay this much. Is that not accurate?
MR. DEAL: That is accurate.
REP. PEARCE: Okay.
Mr. Rusco, you -- what was GAO saying the stakes were last year in this '98-'99 lease, the offshore leases? How much was going to be lost in the Kerr-Mcgee case?
MR. RUSCO: I am sorry I don't remember the exact figure. I'll have to get back to you on that.
REP. PEARCE: If I gave you a number, would you verify it? Because I'm going to give you a number; ($)60 billion is what GAO said last year. Publicly they said ($)60 billion is at stake. How much is at stake this year, in your opinion?
MR. RUSCO: We have not updated that work since the Kerr-Mcgee ruling, the recent Kerr-Mcgee ruling.
REP. PEARCE: I'm sorry, we're not -- can you --
MR. RUSCO: I'm sorry. We have not updated our --
REP. PEARCE: MMS is saying ($)20 billion this year after a study. So you're 300 percent off. You say these audit reports that declare -- and KPMG can't say this stuff. They can't say this that's in conformity. And they do, they say it's in conformity.
I wonder if your GAO report is 300 percent off, like your estimate on the amount we achieved. Thank you very much.
REP. COSTA: All right, the gentleman's time has expired.
Mr. Rusco, this may be appropriate for you. There's -- in the Royalty-in-Kind Program there's an industry practice that I've learned about that's called "swinging."
In California and other places we used to refer to swinging as a different concept, but my understanding is --
(Laughter)
REP. COSTA: -- that when the price is low, I mean, the industry provides more of supply and when the price is high, they provide less. I guess that's the definition more or less.
Do you think you could explain that practice and whether or not you think that's a problem with the Royalty-in-Kind payment?
MR. RUSCO: The process would exist if a Royalty-in-Kind -- and I will speak for gas producers in particular because there's been a case that MMS identified of that going on in natural gas.
This would be the case if MMS had contracted with someone to provide natural gas Royalty-in-Kind and then sold that to a buyer and then the deliveries would vary according to the price of natural gas and the deliveries would be lower if the prices were higher and greater if the prices were lower.
That's what the -- that's what swinging is, and MMS did identify some of that going on.
REP. COSTA: So you think it may be a problem?
MR. RUSCO: The extent of which -- the problem we don't know, but we do know that it has happened in the past. The --
REP. COSTA: All right.
MR. RUSCO: -- MMS has identified it. You'd have to ask them.
REP. COSTA: Okay, before my time expires -- Mr. Devaney, you've expressed concerns in the culture -- about the culture, in your own testimony, of the Royalty-in-Kind Program in the past, especially as it relates to ethics, potential ethics violations that are on -- your investigations, I know, are now ongoing and I know that you can't speak specifically about that, but I'd like to get a general sense without talking about the specifics.
Whether or not we're talking about petty types of crime or whether we're talking about wholesale criminal intent that could cost the American treasury significant amounts of money?
MR. DEVANEY: I think the way I'd like to answer that, Mr. Chairman, is most of the continued investigations involve personnel behavior, at a minimum ethical lapses with potential criminal violations involved as well.
I think that has stopped and I think the department has made some personnel changes that were very helpful. I think at the end of the day, if people are not prosecuted, we're going to turn this matter over to Assistant Secretary Allred for administrative action and I'm confident that he'll take that action.
REP. COSTA: All right, Mr. Rusco and Mr. Devaney, there's been a recommendation from the Royalty Policy Committee that Mr. Deal is dealing with that they establish a trust-fund for MMS operations.
What do both of you think about that, quickly?
MR. DEVANEY: I'll just say that I really don't have an opinion on that.
REP. COSTA: Mr. Rusco?
MR. RUSCO: We've not addressed that either.
REP. COSTA: You haven't? Okay. The -- Mr. Rusco, talked about the focus of Mineral Management Services on compliance review versus audits and the lack of -- I was inferring from your testimony that you were suggesting that they perform greater focus on audits than compared to review -- compliance review.
Would you like to speak a little more detail about the problems and why you think so?
MR. RUSCO: Yes. I think that -- in our work we found that the data coming in to MMS were unreliable, that there aren't enough controls on that data, there aren't verification with third party data and as a result of that, when MMS does compliance reviews or audits, they frequently find that additional royalties are due and we are concerned about the mix of compliance reviews and audits because compliance reviews are less rigorous than audits.
However, we don't -- we are not commenting on the precise mix because we have not evaluated that.
REP. COSTA: Well, you know, when I talked to Mineral Management Services and I talked about how many auditors they have and whether or not they have sufficient tools to do the job, and I think about the companies that they're engaged with and how sophisticated and operating they are, it just seems like a lot of paper manual entries are taking place.
Why can't a lot of this data be automated and transferred to Mineral Management Services computer, with paper copies being kept for independent reviews?
Just seems to me like so much of their effort, notwithstanding the $150 million investment, has gone for naught. Quickly.
MR. RUSCO: We agree that the IT systems are inadequately designed and there are many gaps that need to be filled.
REP. COSTA: Okay, all right, good. My time has run out. Do either of you have a quick comment on that? You concur, disagree?
MR. : I would concur. I think this IT system really needs to be fixed.
REP. COSTA: All right, very good. The gentleman from New Mexico is up to the plate again, for five minutes.
REP. PEARCE: Thank you, Mr. Chairman.
Mr. Devaney, what is your definition of timely? In other words, we asked for timely responses back, so if we have some questions today, what's timely if -- to get an answer back?
MR. DEVANEY: Well, I'll give it back as soon as I possibly can.
REP. PEARCE: About how much?
MR. DEVANEY: Two weeks.
REP. PEARCE: Two weeks. You're aware that we asked you last year about why you excluded the letter from Carolina Calore (ph) out of your report.
You said there was no smoking guns to say that the Clinton administration purposely left of and so we brought the smoking gun and we gave it to you and you never really responded to that.
And so by your own definition, a couple of weeks -- that's a month and 12 months, 13 months. I'd really appreciate you getting back with us on that, sir.
MR. DEVANEY: I --
REP. PEARCE: The -- in your testimony, you say that MMS is not using risk-based strategy for compliance reviews.
Mr. Deal, did you find any evidence that risk-based strategies are being used?
MR. DEAL: Well, we did.
REP. PEARCE: That's odd. You did or didn't? Yes, you did?
MR. DEAL: But I didn't.
REP. PEARCE: You did not?
MR. DEAL: No. We did, but we found the need for more rigor and clarity.
REP. PEARCE: But you found some use of risk-based strategy?
MR. DEAL: Yes. Yes.
REP. PEARCE: So, Mr. Devaney, your comments last year were that there was no risk-based strategy in your comments.
Did you actually go to MMS and ask them if they had implemented, because in the report I find that we need -- that we have implemented significant risk-based strategies in the last 12 months. And again I wonder about your definition of timely.
When was the last time you went to talk to MMS about that?
MR. DEVANEY: Well, Mr. Pearce, I think that, you know, when we did that audit, we didn't find that MMS was adequately using a risk- based strategy.
REP. PEARCE: When did you --
MR. DEVANEY: Today, I think they are.
REP. PEARCE: Yeah, but your testimony today says they're not doing it. And I'm wondering if you did any more -- no, you didn't do any more timely look on this and you did not --
MR. DEVANEY: I'm sorry if you misunderstood my testimony. I was characterizing my prior report. I wasn't talking about today --
REP. PEARCE: I understand you were characterizing your prior report, but people are going to use your words in this hearing today, saying there's no risk-based strategy.
You come here using loose words and I just think that you really should be aware that people are going to use your testimony today, not to characterize what you were wanting to characterize a year ago, they are going to take your report today as if it were given today and as if you actually did something in between last year and this year, which you didn't answer my questions, and I'm assuming -- I have to assume.
I hope that you actually talked to MMS before you came here today to make your assertions here that we are not doing our job, when I find really dedicated public servants that are wrestling with a very complex issue.
Now, in your testimony last year you mentioned these four investigations. Have you turned that over to DOJ? That's pretty serious allegations of misconduct. Did you turn that over to DOJ?
MR. DEVANEY: Yes, we've been working with them all along.
REP. PEARCE: And so DOJ has had that information for 13 months?
MR. DEVANEY: It's not a matter of turning the investigation over. It's a matter -- we've been working with DOJ for 13 months.
REP. PEARCE: No, but this is a serious allegations you're making in front of this committee, and has DOJ decided to prosecute or not?
MR. DEVANEY: They have not made that decision yet.
REP. PEARCE: They haven't even made a decision. They've had it for 13 months, you know, you come here and you talk about. The -- you mentioned the qui tam cases.
MR. DEVANEY: Right.
REP. PEARCE: What happened, Mister -- we all remember Mr. Maxwell (ph). He was in front of this -- talking about the same thing.
What happened to his case in court?
MR. DEVANEY: I believe that was -- I believe it was found in his favor in court.
REP. PEARCE: Oh, it was found in his favor?
MR. DEVANEY: Right.
REP. PEARCE: Can I check with staff? It was found not to have standing. Also he was found not to have standing, and I wonder about your internal processes when you write your report
He took his case straight to the court. You mentioned that in your testimony and yet he was thrown out of court for not having standing, and yet you talk today about it as if it were still a legitimate thing that he did and Mr. Maxwell was pitched out of court because he did bypass all and I wonder what your internal controls are doing about people who would go outside the system to try to get personal gain.
Now, this is actually -- Mr. Rusco -- an actual documented circumstance of somebody's behavior that would say we ought to be suspicious, yeah, but don't find that suspicion directed there, we find the suspicious stuff directed -- I have got a very complex report that states over and over that -- that it's pretty good.
Yeah, we can -- we've got a 100 desertions that could be dealt with but overall it's pretty good and then I've got Mr. Devaney's report and I've got Mr. Rusco's report that says diametrically opposed, and I just wonder what facts are looked at.
Thank you, Mr. Chairman, I appreciate your indulgence.
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REP. PEARCE: Well, we may not complete my questioning till 2:00 or 3:00 o'clock then, I'm sorry to hear the Chairman say that.
REP. COSTA: I won't be here until 2:00 or 3:00 o'clock, but I will --
REP. PEARCE: Okay, thank you, Mr. Chairman, I'll get on to my questions.
REP. COSTA: God speed.
(Laughter)
REP. PEARCE: The -- Mr. Luthi, what would it take, I mean, you heard the testimony Mr. Rusco was feeling like all the oil and gas operators are out there to cheat the American government and the American people, what would it take to cheat on your royalties? Beginning at what level to be significant?
MR. LUTHI: Thank you, Mr. Chairman and Representative Pearce --
REP. PEARCE: Speak closer if you would, we need the -- and push the button. Yeah.
MR. LUTHI: There we go.
REP. PEARCE: Okay.
MR. LUTHI: To paraphrase your question a little bit, what would it take to cheat on the royalties.
REP. PEARCE: Yeah.
MR. LUTHI: It takes quite a complicated process as far as I can understand, because your royalty is developed upon basic formula of volume --
REP. PEARCE: Yeah.
MR. LUTHI: -- value and the royalty that's set. The only set standard there is the royalty amount, whether it be 18-3/4 percent, 12-1/2 percent, whatever that is.
So then you go back and you look at the volume and the value of either the gas or the oil.
The volume is normally run through at least one, if not several meters, so there isn't opportunity to have --
REP. PEARCE: So, you'd have to have meters that don't work, that have been jimmied with and then you'd have to complicity up and down.
In other words, the guy at the field -- if the guy at the top, the CEO, says cheat, you've got to have the mid-level say cheat and then you've got to have the guy at the field level say cheat, and they all have to kind of agree.
But then you got different operators at the well, so if I can talk this guy over here on the ground that actually pumps and works that well to cheat, I have to also get every single guy out there at field level. CEO, you could get one guy that issued the instructions, then you got different mid-level people.
We got individuals on the ground and if one of them -- if one of them says, I'm not going to do that, I'm going to report you, isn't that, I mean, I just find that absurd, that we have a GAO report that begins to say that we've got that sort of -- have you all stumbled on any kinds of complicity like that throughout the nation?
MR. LUTHI: No, we haven't, congressman.
REP. PEARCE: Okay, all right. The document that came out actually as we looked through it was -- it came up with a lot of findings and about a 100 more recommendations, but at the beginning it says the process is working well, but yes, it could be tuned up a lot.
How many of those findings had you already started implementing even maybe before the findings were given, or since you'd seen the report?
How -- tell me a little bit about the contrast of MMS today versus maybe the MMS of the Clinton years.
MR. LUTHI: Okay. That's going back a few years, but yes, the findings, many of the findings, especially those 16 that I referenced in my testimony, we actually had underway.
A good example of that -- or they were the easy ones to fix. One of those was the Indian Oil Valuation Rule. That particular one wasn't easy to fix.
So it's a very complex, it's an important rule, but what it does is help to -- help clarify how we value Indian oil.
That is out, it's on the street, it's out there now. Other things that we did, we did recommend, and it has been done.
We have the subcommittee now dedicated to RIK. We've been -- increased some security of the easy stuff on the computers, the passwords.
The coordination was a big factor, which I thought the subcommittee did an excellent job of identifying and we've broken down some barriers.
It's amazing to me, as coming from a small, you know, Wyoming, I would say bureaucracy, you know, legislature, to see how we do get in our own stovepipe area and we don't have a chance for those that are actually monitoring the meters, seeing the producers on a daily basis, don't always have that coordination with those that are actually requesting the money be paid.
We've broken that down. We're very pleased with the progress we've been making.
REP. PEARCE: Well, I think that's an important piece to know from this hearing today that one report says that you're doing fairly well, and you're even implementing many of the findings before and during and by the way, you can go out to New Mexico, they spent almost $200 million -- I was on the appropriating committee -- trying to work out this thing.
We're trying to figure out the royalty payments and New Mexico's budget at that time was maybe $2 billion and we spent ($)200 million, so you can imagine kind of how trying that was.
It was very complex. Mr. Finfer, if it's that complex to figure out the royalties, because the well-head prices are different every day, you've got a flow-linked (ph) price, and then you've got people that got all these partners and sub-partners and unit operators and unit members.
Tell me a little bit about the Royalty-in-Kind Program. I continue to see it to be a fairly simple operation compared to the other operation that we spent billions or millions or whatever. Tell me a little bit about the RIK.
MR. FINFER: RIK isn't foolproof, but yes, it is simpler. It's a more cut-and-dried process and one of the ways in which it has an advantage is, as you know, there have been many disputes about valuation over the years.
Just simply writing the valuation rules took 10 years or so and in the royalty value program, there are many disputes about valuations, deductions and so forth that can take quite a bit of time to resolve.
Royalty-in-Kind has less of that sort of a problem and so there's a significant advantage in that regard.
REP. PEARCE: So if I understand it correctly, it's not foolproof but it might be damn foolproof, so if you get it narrowed down.
Okay, Mr. Chairman, I see my time is out and we've come within one minute of your expectations of a noontime adjournment. So I'd thank you for your indulgence all day long. Appreciate it.
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