GAO-11-318SP: Energy: Improved management of federal oil and gas resources could result in approximately $1.75 billion over 10 years

Energy

Improved management of federal oil and gas resources could result in approximately $1.75 billion over 10 years

Why Area Is Important

 

The Department of the Interior (Interior) collected approximately $40 billion in oil and gas revenues from company bids for new oil and gas leases, annual rents on existing leases, and royalties paid on oil and gas sold from federal leases in fiscal years 2008 through 2010. Interior's Bureau of Land Management (BLM) manages onshore oil and gas leases, and its Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) manages offshore leases. Interior's Office of Natural Resources and Revenue (ONRR) is responsible for collecting revenues associated with oil and gas produced from onshore and offshore leases.

GAO has reviewed Interior's oil and gas management and revenue collection and found in September 2008 that Interior has not routinely evaluated its federal oil and gas revenue collection system. By not evaluating this system, Interior is unable to state whether current revenue policies ensure that the federal government is receiving a fair return on the production and sale of oil and gas produced from federal leases.

What GAO Found

Revising Interior's federal oil and gas revenue collection system represents an opportunity to collect substantial additional revenues from the development of federal oil and gas resources. In fiscal year 2010, Interior estimated that increasing both rental rates for non-producing oil and gas leases and onshore oil and gas royalty rates would generate over $1.7 billion over 10 years.

A considerable body of legislation governs Interior's authority and obligations to manage resources on federal lands and within federal waters. For example, under the Outer Continental Shelf Lands Act[1] and the Federal Land Policy and Management Act,[2] Interior must ensure the United States receives fair market value on the development of its oil and gas resources. The federal government receives payment for the development of oil and gas resources on federal lands and waters in potentially three ways. First, to obtain federal leases, companies generally must pay the federal government an amount—called a bonus bid—determined through a competitive auction. Second, after the lease is awarded, companies must pay rent to hold the land. Onshore, for example, the rental rate is generally between $1.50 and $2 per acre per year. Third, after production begins, the companies must accurately measure the oil and gas volumes and pay royalties to Interior based on a percentage of the cash value of oil and gas produced and sold. The royalty rates for onshore leases are generally 12.5 percent, while royalty rates for offshore leases in the Gulf of Mexico generally range from 12.5 percent to 18.75 percent.

In October 2008, GAO reported that Interior does less to encourage development of oil and gas on federal leases than some states and private landowners. Moreover, some of the tools that states and private landowners use may also result in increased revenues. For example, four of the eight states GAO reviewed increase rental rates over time on nonproducing oil and gas leases to (1) encourage faster development of oil and gas resources—on which royalties are due, and (2) increase revenues from nonproducing leases. While Interior officials stated that rental rates for a 10-year onshore federal lease increased from $1.50 per acre per year for the first 5 years to $2 per acre per year for years 6 through 10, states GAO reviewed typically increased rental rates to a greater extent. For example, one state increases the rental rate from $5 per acre per year to $25 per acre per year if the lease is not developed by the end of the third year.

In September 2008, GAO reported that Interior had not conducted a comprehensive evaluation of the oil and gas revenue system in over 25 years and that it did not have a system in place to evaluate whether the federal system is in need of reassessment. At the time, GAO also reported that Interior collected lower levels of revenues for oil and gas production than do some resource owners, including other countries and some U.S. states. For example, GAO reported that federal revenues for oil and gas produced in the Gulf of Mexico were lower than 93 out of 104 resource owners. In addition, the lack of price flexibility in royalty rates—automatic adjustment of these rates to changes in oil and gas prices or other market conditions—and the inability to change fiscal terms on existing leases put pressure on Interior and Congress to change royalty rates in the past on an ad hoc basis with consequences that could amount to billions of dollars of foregone revenue. For example, special lower royalty rates—referred to as royalty relief-granted on leases issued in the deep water areas of the Gulf of Mexico from 1996 to 2000 (a period when oil and gas prices and industry profits were much lower than they are today) could result in $21 billion to $53 billion in lost revenue to the federal government, compared with what it would have received without these provisions. GAO's 2008 User Fee Design Guide also notes the importance of regular fee reviews to determine whether a fee needs to be adjusted. User fees represent a charge to readily identifiable users of a government service or benefit above and beyond what is normally available to the general public. Further, fee reviews can facilitate effective communication and provide opportunity for stakeholder input. GAO has previously reported that such communication with stakeholders can provide feedback that could affect the outcome of changes in fees and program implementation.

In 2010, GAO issued two reports that found Interior's verification of the volume of oil and gas produced from federal leases—on which royalties are due to the federal government—does not provide reasonable assurance that operators are accurately measuring and reporting these volumes. In March 2010, GAO reported that Interior's measurement regulations and procedures for oil and gas measurement were insufficient for providing reasonable assurance that oil and gas were being measured accurately. As a result, there is a risk that the government is not receiving all the oil and gas royalties it is due. Additionally, GAO reported in October 2010 that Interior's data likely underestimated the amount of natural gas produced on federal leases that is released directly to the atmosphere (vented) or is burned (flared). This vented and flared gas contributes to greenhouse gases and represents lost royalties. It is also important to consider the costs of verification and validation in the context of the benefits likely to be realized. GAO's User Fee Design Guide discusses the importance of striking a balance between ensuring compliance and minimizing the administrative costs of collection.

Interior has begun to address these issues. For example, in January 2007, Interior announced that it was raising the royalty rate for new deep water leases in the Gulf of Mexico from 12.5 percent to 16.7 percent. At that time, Interior estimated that the increased royalty rate of 16.7 percent for new deepwater offshore Gulf of Mexico leases would increase revenue from royalty payments by $4.5 billion over 20 years. Interior also estimated that the increase in royalty rates would decrease the amount companies would bid for the rights to explore for and develop oil and gas on affected leases as well as reduce the amount of oil and gas ultimately produced in affected areas, but that in net, the increase in revenue would be greater than the reductions associated with lower bids and production. Furthermore, in response to GAO's October 2008 report, Interior stated in 2010 that the administration would propose legislation to impose a fee on new nonproducing oil and gas leases to encourage energy development on both onshore and offshore leases. To date, such a fee has not come into effect. However, in an April 12, 2010, press release, Interior stated that it is undertaking a study in response to GAO's September 2008 report, which it expects to complete in 2011. The purpose of the study is to inform decisions about federal lease terms, such as royalties, by consistently comparing the federal oil and gas fiscal systems with such systems of other countries. Specifically, Interior stated that the results of this study will enable it to ensure that its leasing policies give the public a fair return on federally owned oil and gas resources, while balancing other objectives, including production and environmental quality. The results of the study may reveal the potential for greater revenues to the federal government. Given the significant financial stakes, there may be opposition from the oil and gas industry. Interior may also face significant difficulties designing and implementing an entirely new revenue collection system, given its recent struggles to successfully oversee oil and gas production. Finally, while Interior agreed with the recommendations from both reports issued in 2010 addressing improvements to its oversight of the measurement of oil and gas produced from federal leases, it has not yet implemented these recommendations.



[1]Pub. L. No. 83-212, 67 Stat. 462 (1953) (codified as amended at 43 U.S.C. §§ 1331-1356a).

[2]Pub. L. No. 94-579, 90 Stat. 2743 (1976) (codified as amended at 43 U.S.C. §§ 1701-1784).

Actions Needed

To encourage companies to diligently develop oil and gas leases, ensure that the government obtains a fair return on oil and gas produced from federal leases, and for Interior to have reasonable assurance that oil and gas produced from federal oil and gas leases is being measured accurately:

  • Congress may need to take action to authorize or encourage Interior to revise its rental fee structure for nonproducing leases.
  • Interior should complete its study examining how other oil and gas resource owners select fiscal parameters for leasing and adjusting oil and gas royalty rates and use that information to adjust, as appropriate, its royalty rates to a level that ensures the government a fair return.In doing so it should ensure opportunities for substantive, two-way communication with program stakeholders.
  • Depending on the results of the study, Congress may wish to provide additional guidance or take additional actions to enable Interior to change how it oversees federal lands and waters and the revenues derived from production of oil and gas there.
  • Interior should implement GAO's recommendations from prior reports addressing a variety of oil and gas measurement factors.

According to Interior, increasing the rental fee for onshore nonproducing leases to $4 per acre per year would generate $760 million over 10 years. While the total additional revenue generated by adjusting both onshore and offshore royalty rates is uncertain, a 2010 Interior estimate of increasing onshore royalty rates projects additional federal revenues of $1 billion over 10 years.

Framework for Analysis

The information contained in this analysis is based on the related GAO products listed under the "Related GAO Products" tab.

Area Contact

For additional information about this area, contact Frank Rusco at (202) 512-3841 or ruscof@gao.gov.

Related GAO Products

Federal User Fees: A Design Guide
http://gao.gov/products/GAO-08-386SP

GAO-08-386SP: Published: May 29, 2008. Publicly Released: May 29, 2008.