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Government Billions of Dollars but Uncertainty Over Future Energy 
Prices and Production Levels Make Precise Estimates Impossible at this 
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April 12, 2007: 

Congressional Requesters: 

Subject: Oil and Gas Royalties: Royalty Relief Will Cost the Government 
Billions of Dollars but Uncertainty Over Future Energy Prices and 
Production Levels Make Precise Estimates Impossible at this Time: 

Oil and gas from federal lands and waters is critical to meeting the 
nation's energy needs, providing about 35 percent of all oil and 25 
percent of all the natural gas produced in the United States in fiscal 
year 2005. Oil and gas companies that lease federal lands and waters 
agree to pay the federal government royalties on the resources 
extracted and produced from these leases. In 1995--a time when oil and 
natural gas prices were significantly lower than they are today-- 
Congress passed the Outer Continental Shelf Deep Water Royalty Relief 
Act of 1995 (DWRRA), which authorized the Department of the Interior's 
(Interior) Minerals Management Service (MMS) to provide "royalty 
relief" on oil and gas produced in the deep waters of the Gulf of 
Mexico from leases issued from 1996 through 2000. This "royalty relief" 
waived or reduced the amount of royalties that companies would 
otherwise be obligated to pay. In implementing the DWRRA for leases 
sold in 1996, 1997, and 2000, MMS specified that royalty relief would 
only be applicable if oil and gas prices were below certain levels, 
known as "price thresholds," thereby protecting the government's 
royalty interests should oil and gas prices increase significantly. MMS 
did not include price thresholds for leases it issued in 1998 and 1999. 
Because oil and natural gas prices have risen significantly in recent 
years, the omission of price thresholds on the leases issued in 1998 
and 1999 has resulted in significant foregone royalties to the federal 
government. In an effort to recoup some of these royalties, Interior is 
currently negotiating with some of the oil and gas companies that own 
these leases. Congress has also been considering legislative actions to 
recoup foregone royalty revenues on these leases or to encourage 
companies to negotiate with MMS. In addition to the foregone royalties 
on the 1998 and 1999 leases, one company, Kerr-McGee, is currently 
pursuing a legal challenge to the Interior's authority to place price 
thresholds on any deep water leases issued between 1996 and 2000 under 
the DWRRA.[Footnote 1] If successful, this legal challenge would lead 
to additional foregone royalties on leases issued in 1996, 1997, and 
2000. 

We reported to the Senate Committee on Energy and Natural Resources in 
January 2007 that the royalty relief for leases issued under the DWRRA 
will likely cost the federal government billions of dollars, but that 
the final costs have yet to be determined.[Footnote 2] At that time, 
MMS' most recent estimates of forgone royalties were made in October 
2004. In light of these findings, you asked us to evaluate the 
potential for foregone royalties resulting from the omission of price 
thresholds on the leases issued in 1998 and 1999. We are also reporting 
on the status of Kerr-McGee's legal challenge to the Interior's 
authority to set price thresholds for the leases issued in 1996, 1997, 
and 2000 under the DWRRA, and the potential implications this challenge 
could have on federal royalty revenues. 

To evaluate the potential for foregone royalties on the 1998 and 1999 
leases, we reviewed estimates made by MMS in October 2004 as well as 
its updated estimates from February 2007. Specifically, we reviewed 
MMS' methodology and assumptions that were used to estimate the amount 
of future oil and natural gas production from DWRRA leases, and we 
examined the timing of this future production using decline curve 
analysis--an engineering tool that projects future production based on 
the decline in past production. We also reviewed statistical data on 
field sizes, discovery success rates, and drilling rig availability in 
the deep waters of the Gulf of Mexico to assess the likelihood of 
future oil and gas discoveries on DWRRA leases. In addition to 
reviewing MMS' estimates, we developed and analyzed a series of 
scenarios to study the uncertainty surrounding estimates of future 
foregone royalties. These scenarios used a range of assumptions about 
oil and natural gas prices and future production levels. Since MMS has 
not yet updated its estimate of the forgone royalties from leases 
issued in 1996, 1997, and 2000 should thresholds no longer apply, we 
did not have all of the available data to fully report on expected 
future foregone royalties on these leases. However, we did evaluate 
MMS' methodology and assumptions used to make its 2004 estimate of 
foregone revenue during the three year period and provide our comments 
on this. We also collected information from MMS on the amount of 
royalties that have already been collected on the 1996, 1997, and 2000 
leases, which may need to be refunded if the federal government loses 
the ongoing legal challenge related to these leases. Finally, we worked 
with MMS and reviewed legal documents to provide an update on the 
status of the legal challenge. A more detailed description of our scope 
and methodology is provided in enclosure 1. We conducted our review 
from September 2006 through March 2007 in accordance with generally 
accepted government auditing standards. 

In summary: 

The absence of price thresholds in leases issued in 1998 and 1999 has 
already cost the government about $1 billion and MMS' most recent 
estimate in February 2007 indicates a range of future foregone 
royalties of between $6.4 billion and $9.8 billion over the lives of 
the leases. We believe the methodology and assumptions used by MMS to 
make these estimates are reasonable. However, because there is 
considerable uncertainty about future oil and natural gas prices and 
production levels, actual foregone royalties could end up being higher 
or lower than MMS's estimates. Our analysis shows that future foregone 
royalties are quite sensitive to changes in prices or in the amount of 
oil and natural gas produced. For example, one scenario that assumed 
high production levels and a price of $70 per barrel for oil and $6.50 
per thousand cubic feet for natural gas--prices that are higher than 
those used by MMS but within the range of recent market prices-- 
indicated that the future foregone royalties could be as high as $10.5 
billion. Alternatively, a scenario that assumed low production levels 
and $50 per barrel for oil and $6.50 per thousand cubic feet for 
natural gas indicated that future forgone royalties could be as low as 
$4.3 billion. MMS is currently negotiating with oil and gas companies 
to apply price thresholds to future production from the 1998 and 1999 
leases. To date, the results of these negotiations have been mixed --6 
of the 45 companies involved have agreed to terms; others have agreed 
to negotiate but have not yet come to terms; and some companies have 
yet to agree to negotiate. 

With regard to the legal challenge to the Interior's authority to 
include price thresholds on leases issued under the DWRRA, Kerr-McGee 
filed suit in early 2006, but agreed to enter mediation with Interior 
in an attempt to resolve the issue. The mediation was unsuccessful and 
litigation has resumed. If the government loses this litigation it will 
lead to additional foregone royalty revenues from the 1996, 1997, and 
2000 leases that included price thresholds. The additional foregone 
royalty revenues could include royalties on these leases totaling 
approximately $1 billion that have already been collected and which may 
have to be refunded as well as royalties on future production. MMS 
estimated in October 2004 that potential foregone royalties on future 
production could be up to $60 billion over the life of the leases, 
should the federal government lose the legal challenge. In our review 
of the methodology and assumptions used in MMS' estimate, we found that 
MMS may have over-estimated the amount of oil and natural gas that 
would be produced from these leases over the course of their lifetime. 
MMS officials agreed with this assessment and said that an updated 
estimate of foregone revenue from these leases might be considerably 
lower than the $60 billion figure but that they are not currently 
working to develop a revised estimate. 

The Congress needs accurate and timely information to consider 
legislative action to recoup forgone royalties. Because the amount of 
royalties potentially recouped from such action may be dependent upon 
fluctuating oil and gas prices and changing production volumes, we are 
recommending that MMS provide to the Congress (1) the status of the 
leases and the annual amount of royalties that have been foregone on 
the 1998 and 1999 DWRRA leases until the issue is resolved, (2) the 
status of the leases and the annual amount of royalties collected to 
date from the 1996, 1997, and 2000 DWRRA leases until the Kerr-McGee 
suit is resolved, and (3) periodic estimates of future foregone 
royalties from 1998 and 1999 DWRRA leases and future royalties that may 
be at risk from 1996, 1997, and 2000 DWRRA leases until these issues 
are resolved. 

Failure to Include Price Thresholds in 1998 and 1999 Leases Will Cost 
the Government Billions in Foregone Royalty Payments: 

As Assistant Secretary Allred of the Department of the Interior 
recently testified before the Congress, the absence of price thresholds 
in leases issued in 1998 and 1999 has already cost the government 
almost $1 billion. In February 2007, MMS estimated a range of potential 
future foregone revenue for these leases of between $6.4 billion and 
$9.8 billion. MMS calculated these estimates under a range of 
assumptions about oil and natural gas prices and future production 
levels. MMS used two price assumptions--one employing a constant price 
of $45 per barrel of oil equivalent and the other using the Office of 
Management and Budget's projected oil and gas prices, which escalate 
through time.[Footnote 3] For future production volumes from the 1998 
and 1999 leases, MMS made low and high estimates--the low estimate did 
not allow for expected growth in oil and natural gas reserves, while 
the high estimate included expected growth in reserves based on past 
experience with oil and natural gas leases in the Gulf of 
Mexico.[Footnote 4] Reserves are the amount of oil (or natural gas) 
that is believed to be economically recoverable at current technology 
and prices. Reserve growth is the tendency of the initial reserve 
estimates to increase or "grow" in the future as more becomes known 
about the oil and gas field. We reviewed MMS' assumptions and 
methodology for estimating the potential foregone revenue from 1998 and 
1999 leases and found them to be reasonable. 

In order to provide further perspective on just how much these future 
costs may vary, we developed and analyzed different scenarios that 
illustrate how the cost to the federal government is sensitive to 
changes in both oil and natural gas prices and future production 
volumes.[Footnote 5] In developing these scenarios, it is important to 
understand that the three key variables that determine total federal 
royalty revenues are production volume, sales price, and royalty rate. 
Royalties paid to the federal government are then calculated using the 
following equation: Royalty Revenue = volume sold x sales price less 
deductions x royalty rate. 

Accordingly, our scenarios employ a range of values for oil and natural 
gas prices and future production volumes to illustrate the uncertainty 
surrounding potential foregone federal royalty revenues.[Footnote 6] 
Since oil and natural gas prices have historically been volatile, we 
selected a variety of prices, ranging from a low of $36 per barrel of 
oil to a high of $70 per barrel and a low of $4.50 per thousand cubic 
feet of natural gas to a high of $6.50 per thousand cubic feet. In our 
analyses, we assumed that price thresholds would rise 2.1 percent per 
year, based on their average annual increase over the past 10 years. 
Similarly, our scenarios included low and high volume estimates for 
future oil and natural gas production from these leases. In these 
scenarios, the estimated foregone royalty revenues vary significantly. 
For example, an oil price of $50 per barrel and a natural gas price of 
$6.50 per thousand cubic feet and low production volumes results in 
$4.3 billion in foregone royalties.[Footnote 7] With the same prices 
but higher production volumes, this estimate increases to $7.4 billion. 
Alternatively, with $70 per barrel of oil and $6.50 per thousand cubic 
feet of natural gas, the low production volume assumption yields 
foregone royalties of $6.2 billion and the high production volume 
assumption yields $10.5 billion. For more detailed information on each 
of the scenarios and the estimated potential foregone royalty revenue, 
see enclosure 2. 

To recoup some of the potential foregone revenue on the 1998 and 1999 
leases, MMS is currently negotiating with oil and gas companies in an 
attempt to apply price thresholds to future production from these 
leases. If successful, this approach would partially undo the omission 
of price thresholds for future production, thereby implementing the 
royalty relief as though price thresholds had been included in the 
leases. However, the results of these negotiations have been mixed--as 
of late February, 2007, only 6 of 45 companies had agreed to terms, 
while others were either negotiating or had not yet agreed to 
negotiate. Moreover, uncertainty about the current legal challenge to 
Interior's authority to set price thresholds on any DWRRA leases may 
further deter or complicate negotiated settlements. 

A Successful Challenge to Interior's Authority to Include Price 
Thresholds On Leases Issued Under the DWRRA Could Cost the Government 
Billions In Additional Revenues: 

Kerr-McGee filed suit against the Department of the Interior in early 
2006, challenging its authority to place price thresholds on any of the 
leases issued under the DWRRA. In particular, this suit seeks to in 
effect, remove price thresholds from leases issued in 1996, 1997, and 
2000. In June 2006, Kerr-McGee agreed to enter into mediation with 
Interior in an attempt to resolve the issue; however, the mediation was 
unsuccessful and litigation has resumed. As of July 2006, the 1996, 
1997, and 2000 leases have generated approximately $1 billion in 
royalties. If the government loses this legal challenge, it may be 
required to refund these royalties and to forego future royalties on 
these leases.[Footnote 8] As a result, the government could stand to 
lose billions of additional dollars. In addition to the impact on 
royalties on the 1996, 1997, and 2000 leases, losing the suit brought 
by Kerr-McGee would also impact the government's negotiation of price 
thresholds for the 1998 and 1999 leases. 

MMS estimated in October 2004 that foregone royalties on the 1996, 
1997, and 2000 leases could be as high as $60 billion. Because much has 
been learned about the productivity of the leases since that initial 
estimate and because price expectations have changed, an updated 
estimate may differ significantly from the 2004 estimate. 

For example, of the 2,369 leases issued in 1996, 1997, and 2000, 1,294 
have expired without ever producing oil or gas. Of the remaining 
leases, 12 have produced and have either reached the end of their 
productive lives or appear incapable of further production; 38 were 
still producing as of July 2006; 26 appear capable of producing in the 
future after being connected to infrastructure; and 999 are still 
active but untested for oil and gas. On the other hand, oil and natural 
gas prices have increased since the estimate of foregone royalties in 
2004. In our review of the methodology and assumptions used in MMS' 
2004 estimate, we found that MMS may have made overly optimistic 
assumptions about the amount of oil and natural gas production that 
would occur over the lifetime of these leases. MMS officials agreed 
with this assessment and also agreed that a new estimate of potential 
foregone royalties might be considerably lower than their earlier $60 
billion figure. However, MMS officials told us that they are not 
currently working to update these figures. 

Conclusions: 

It is impossible to precisely estimate how much royalty revenue the 
federal government could lose as the result of the 1998 and 1999 leases 
that did not include price thresholds or if Interior loses the legal 
challenge to its authority to include price thresholds for the leases 
issued in 1996, 1997, and 2000, because of the inherent uncertainty of 
future oil and natural gas prices and production volumes. Nonetheless, 
MMS estimates of foregone royalty revenues from 1998 and 1999 leases 
seem reasonable, in light of our analysis. There is considerably more 
uncertainty, however, regarding potential foregone royalty revenue for 
leases issued in 1996, 1997, and 2000. Although MMS has not yet updated 
its 2004 estimate of the future potential royalty losses on the leases 
at issue in the Kerr-McGee suit, it is clear that such an update could 
differ significantly from its earlier estimate because of likely 
changes to production and price assumptions. As Congress considers ways 
to address foregone royalties, it will need the best available 
information on a year-to-year basis about royalties that have been 
foregone to-date, those that have been paid but that are at risk in the 
suit, and estimates of how much is at stake going forward. Because new 
information will become available every year that these leases are in 
effect, we expect these figures and estimates to change significantly 
over time. 

Recommendations for Executive Action: 

To assist the Congress in its efforts to find appropriate remedies for 
foregone royalty revenues or those that may be at risk, we recommend 
that MMS report to the Congress (1) the status of the leases and the 
annual amount of royalties that have been foregone on the 1998 and 1999 
DWRRA leases until the issue is resolved, (2) the status of the leases 
and the annual amount of royalties collected to date from the 1996, 
1997, and 2000 DWRRA leases until the Kerr-McGee suit is resolved, and 
(3) periodic estimates, as MMS resources allow, of future foregone 
royalties from 1998 and 1999 DWRRA leases and future royalties that may 
be at risk from 1996, 1997, and 2000 DWRRA leases until both of these 
situations are resolved. 

Agency Comments: 

We provided a draft of this report to the Department of the Interior 
and the Minerals Management Service (MMS) for review and comment. They 
provided oral comments, which we have incorporated as appropriate. In 
general, MMS officials said they agreed with our findings and 
recommendations. Specifically, MMS officials said that providing the 
Congress with both the retrospective annual amounts of foregone 
royalties from 1998 and 1999 DWRRA leases and royalties collected from 
1996, 1997, and 2000 leases would be manageable. However, agency 
officials stated that providing the Congress annual prospective 
estimates of both of these values would require significant work and 
cost. Accordingly, we revised our recommendations to provide MMS with 
the flexibility to develop these estimates as MMS resources allow or as 
needed by the Congress. 

We are sending copies of this report to appropriate Congressional 
committees, the Secretary of the Interior, the Director of MMS, the 
Director of the Office of Management and Budget, and other interested 
parties. We will also make copies available to others upon request. In 
addition, the report will be available at no charge on GAO's Web site 
at http://www.gao.gov. 

If you or your staff have any questions or comments about this report, 
please contact me at (202) 512-3841 or gaffiganm@gao.gov. Contact 
points for our Offices of Congressional Relations and Public Affairs 
may be found on the last page of this report. GAO staff who made 
contributions to this report include Ron Belak, Glenn C. Fischer, Dan 
Haas, Frank Rusco, and Barbara Timmerman. 

Signed by: 

Mark Gaffigan: 
Acting Director, Natural Resources and Environment: 

Enclosures: 

[End of section] 

Enclosure I: Scope and Methodology: 

To determine the fiscal impacts of not including price thresholds on 
deep water oil and gas leases issued under the Outer Continental Shelf 
Deep Water Royalty Relief Act of 1995 (DWRRA), we met with MMS 
personnel in the Economics Division in Herndon, Virginia. We reviewed 
their October 2004 estimate of forgone royalties due to not including 
price thresholds in 1998 and 1999 deep water leases and their estimate 
of royalties that could be forgone if price thresholds did not apply to 
1996, 1997 and 2000 DWRRA leases. We concluded that they followed 
standard engineering and financial practices and had generated the 
estimates in good faith. However, more than two years had passed since 
their estimates, and we believed that the estimates needed to be 
updated. MMS concurred and gave us their preliminary results in March 
2007. We recently reviewed these preliminary results and generally 
concurred with their methodology and assumptions as well as with the 
magnitude of their estimates. During the course of our work in 2006, we 
visited MMS's Gulf of Mexico Regional Office in New Orleans and 
interviewed engineers and geologists on technical aspects of oil and 
gas production in the deep waters of the Gulf of Mexico. In addition, 
we contacted industry representatives for opinions on oil and gas 
exploration and development in the deep waters of the Gulf of Mexico. 

To perform our scenario analysis, we identified within MMS's Technical 
Information Management System (TIMS) all 3,401 leases issued under the 
DWRRA, 1,032 of which were issued in 1998 and 1999. From this database, 
we were able to identify the status of these leases and the extent to 
which they had been explored and developed and the production that had 
occurred on some of them. As of July 2006, a total of 33 of the leases 
issued in 1998 and 1999 have produced, are currently producing, or are 
expected to produce oil and gas in the future. Four of the 33 leases 
have either stopped producing or appear to be no longer capable of 
producing significant amounts; 14 are still producing; and 15 are 
expected to commence production at some future time. As of January 1, 
2007, 563 additional 1998 and 1999 leases were still active but had not 
yet been tested for oil and gas. As of March 28, 2007, 486 of the 
leases issued in 1998 and 1999 have expired, been relinquished, or been 
terminated.[Footnote 9] We also collected from TIMS pertinent 
information current through July 2006 on the status of each lease and 
the estimated reserves of producing leases and leases capable of 
producing but not yet connected to infrastructure (producible leases). 
We interviewed MMS personnel in New Orleans to better understand how 
these reserve estimates were made. For producing and producible leases, 
we corroborated lease information in TIMS with MMS's final bid results. 
We also obtained recent information on reserve growth for each 
producing or producible lease and obtained monthly oil and gas 
production volumes through July 2006 from MMS's Oil and Gas Operations 
Reports (OGOR). We reviewed production data for characteristic decline 
patterns, questioned MMS personnel on how they verified these data and 
on reasons for periods of time with zero production (predominantly the 
result of hurricane activity), and compared each lease's cumulative 
production with reserve estimates in TIMS. We found the data in TIMS 
and in OGOR to be sufficiently reliable for the purposes of our 
analysis. 

In consultation with MMS experts, we estimated the timing of future 
production to identify and exclude from our analysis the possible 
production volumes that will be royalty free when sales prices drop 
below anticipated price thresholds in the future. To determine the 
timing of future production from currently producing leases, we used 
standard decline curve analysis, which projects future production based 
on the declining pattern of past production. For 1998 and 1999 
producing leases, we segregated leases into three zones based on water 
depth, which determines how much production is royalty free. Zone A 
contains leases in waters from 200 to 400 meters deep (17.5 million BOE 
exempt from royalties); zone B contains leases in waters from 400 to 
800 meters deep (52.5 million BOE exempt from royalties); and zone C 
contains leases in waters deeper than 800 meters (87.5 million BOE 
exempt from royalties). We constructed separate decline curves for the 
oil and gas fraction for leases in zone C, but did not do so for leases 
in the A and the B zones because these leases were either not producing 
or were producing insignificant volumes. When constructing decline 
curves, we adjusted for time periods of zero production due to major 
hurricanes. We also ensured that the total production predicted by the 
decline curves was equal to the total reserves estimated by MMS. For 
larger leases, we tracked projected cumulative production to predict 
whether a lease would exceed its royalty suspension volume so as not to 
include the amounts over the suspension volumes in our estimate of 
forgone royalties. 

We also used decline curve analysis to predict the timing of future 
production from producible leases, all of which are in the C zone. In 
consultation with MMS experts, we constructed a composite gas decline 
curve and a composite oil decline curve using production data from all 
producing DWRRA leases in the C zone, adjusted for missing data. Based 
on advice from MMS and industry representatives, we assumed that 
producible leases would produce for 15 years. Based on the 7 year 
average time from discovery to first production of 144 producing fields 
in Gulf of Mexico waters deeper than 800 meters, we assumed that each 
of the producible C zone leases would first start producing seven years 
after its discovery. 

To project production from future discoveries on 1998 and 1999 leases, 
we examined MMS projections for future drilling activity, historic 
discovery rates, average field sizes, and anticipated lease expiration 
dates for DWRRA leases in waters deeper than 800 meters, where MMS 
anticipates all the future DWRRA discoveries to occur. First, we 
assumed that the range for the number of possible untested leases 
drilled in all of the deep waters of the Gulf of Mexico would be 
between 30 and 60. This assumption was based on the availability of 
rigs to drill exploratory wells in waters deeper than 800 meters and 
MMS projections in the 2006 deep water report. Second, we assumed the 
success rate of future deep water lease discoveries would be the same 
as for such deep water leases issued from 1974 through 1995--this 
success rate was 28 percent. Third, we scheduled the expiration dates 
of the 1998 and 1999 leases for each year through 2009 and calculated 
for each of these years the percentage of all untested deep water 
leases below 800 meters that would be 1998 and 1999 leases, assuming 
that there would be 3,700 total active deep water leases each year. 
Fourth, we assumed that each new field discovery would consist of two 
leases because 97 percent of the existing 198 fields in Gulf of Mexico 
waters deeper than 800 meters are composed of from one to four leases, 
with two leases being the average field size. Finally, for 2007 through 
2009, we assumed the number of field discoveries on 1998 and 1999 
leases would be between 5 and 10. This assumption was derived by 
multiplying the estimated range of untested leases that could be 
drilled in all Gulf of Mexico deep waters (30 to 60 per year) by the 
percentage of all deep water leases that are active untested 1998 and 
1999 leases and by the assumed success rate of 28 percent. We doubled 
this number in order to account for the average field consisting of two 
leases. For these new discoveries, we converted these numbers into oil 
and gas production volumes by multiplying them by the average of the 
reserves for all producing and producible DWRRA leases, adjusting for 
the possibility that some leases would have reserves greater than the 
royalty suspension volume of 87.5 million BOE. 

With these assumptions, we developed several scenarios that illustrate 
that the potential for forgone royalties is highly dependent upon 
prices and production volumes. We selected the price scenario of $36 
for oil and $4.50 for gas to illustrate that there would be no forgone 
royalties at these prices because they should remain below predicted 
price thresholds for the lives of the DWRRA leases. We chose prices of 
$50 and $70 for oil and $6.50 for gas because these were in the range 
of common prices during 2006. We did not escalate oil and gas prices 
over the time period of our scenario. However, we increased 2006 price 
thresholds by 2.1 percent per year, based on the average increase over 
the past 10 years. To illustrate the impact of changing production 
volumes on forgone royalties from producing and producible leases, we 
assumed low and high production levels. Our low production assumption 
is equal to MMS's estimated reserves. Our high production assumption is 
equal to MMS's estimated reserves multiplied by the average weighted 
growth factor. To illustrate the impact of changing production volumes 
on forgone royalties from future discoveries, we also selected low and 
high assumptions. Our low production assumption is 5 discoveries, and 
our high assumption is 10 discoveries. We did not multiply production 
assumptions from future discoveries by growth factors but such growth 
is possible. 

[End of section] 

Enclosure II: Scenarios Illustrating the Sensitivity of the Cost to the 
Federal Government to Changes in Oil and Natural Gas Prices and Future 
Production Volumes: 

We present two scenarios below to illustrate the range of potential 
future costs to the federal government that could result from the 
omission of price thresholds in leases issued in 1998 and 1999. 

Scenario 1 illustrates possible foregone federal royalty payments 
resulting from MMS's omission of price thresholds in leases issued in 
1998 and 1999 when oil and natural gas prices exceed price thresholds 
(see table 1).[Footnote 10] Specifically, we selected an oil price of 
$50 per barrel and a natural gas price of $6.50 per thousand cubic feet 
to illustrate the forgone royalties with both low and high volume 
estimates of future oil and gas production. In this scenario, the 
productive timeframe is from August 2006 through the lives of the 
leases--about 25 years. In the low production volume estimate, we use 
MMS's "ungrown reserve" estimates and assume 5 additional leases are 
discovered in the future. Our scenario results in $4.3 billion in 
foregone royalties. This estimate increases to $7.4 billion in the high 
production volume case, which uses MMS' "grown reserves" and 10 future 
discoveries. 

Table 1: Scenario 1 assumes that from 1998 and 1999 leases, oil would 
be sold for $50 per barrel and natural gas would be sold for $6.50 per 
thousand cubic feet. 

Ungrown Reserves and 5 Future Discoveries: 
Grown Reserves and 10 Future Discoveries: 

Foregone royalties on Future Production from Producing and Producible 
Leases; 
Ungrown Reserves and 5 Future Discoveries: $3.8 billion; 
Grown Reserves and 10 Future Discoveries:  $6.0 billion. 

Additional Foregone Royalties on Future Production from Leases with New 
Discoveries;  
Ungrown Reserves and 5 Future Discoveries: $0.5 billion; 
Grown Reserves and 10 Future Discoveries: $1.4 billion. 

Total Foregone Royalties; 
Ungrown Reserves and 5 Future Discoveries: $4.3 billion; 
Grown Reserves and 10 Future Discoveries: $7.4 billion. 

Source: GAO: 

[End of table] 

Scenario 2 illustrates possible forgone royalties with a higher oil 
price, but the price is within the range of prices we have seen in 
recent years (see table 2). Using similar assumptions on production 
volumes as in Scenario 1, $70 per barrel of oil and $6.50 per thousand 
cubic feet of natural gas yields $6.2 billion in forgone future 
royalties for the low estimate and $10.5 billion in forgone future 
royalties for the high estimate. 

Table 2: Scenario 2 assumes that from 1998 and 1999 leases, oil would 
be sold for $70 per barrel and natural gas would be sold for $6.50 per 
thousand cubic feet. 

Foregone royalties on Future Production from Producing and Producible 
Leases; 
Ungrown Reserves and 5 Future Discoveries: $5.2 billion; 
Grown Reserves and 10 Future Discoveries: $8.1 billion. 

Additional Foregone Royalties on Future Production from Leases with New 
Discoveries;  
Ungrown Reserves and 5 Future Discoveries: $1.0 billion; 
Grown Reserves and 10 Future Discoveries: $2.4 billion. 

Total Foregone Royalties; 
Ungrown Reserves and 5 Future Discoveries: $6.2 billion; 
Grown Reserves and 10 Future Discoveries: $10.5 billion. 

Source: GAO: 

[End of table] 

List of Addressees: 

The Honorable Jeff Bingaman: 
Chairman, Committee on Energy and Natural Resources: 
United States Senate: 

The Honorable Carl Levin: 
Chairman, Permanent Subcommittee on Investigations: 
Committee on Homeland Security and Governmental Affairs: 
United States Senate: 

The Honorable Norm Coleman: 
Ranking Member, Permanent Subcommittee on Investigations: 
Committee on Homeland Security and Governmental Affairs: 
United States Senate: 

The Honorable Nick J. Rahall: 
Chairman, Committee on Natural Resources: 
House of Representatives: 

The Honorable Darrel E. Issa: 
Ranking Member, Subcommittee on Domestic Policy: 
Committee on Oversight and Government Reform: 
House of Representatives: 

The Honorable Daniel K. Akaka: 
United States Senate: 

The Honorable Maria Cantwell: 
United States Senate: 

The Honorable Thomas R. Carper: 
United States Senate: 

The Honorable Byron L. Dorgan: 
United States Senate: 

The Honorable Richard J. Durbin: 
United States Senate: 

The Honorable Russell D. Feingold: 
United States Senate: 

The Honorable Dianne Feinstein: 
United States Senate: 

The Honorable Tim Johnson: 
United States Senate: 

The Honorable John F. Kerry: 
United States Senate: 

The Honorable Frank R. Lautenberg: 
United States Senate: 

The Honorable Robert Menendez: 
United States Senate: 

The Honorable Barbara A. Mikulski: 
United States Senate: 

The Honorable Patty Murray: 
United States Senate: 

The Honorable Barack Obama: 
United States Senate: 

The Honorable Jack Reed: 
United States Senate: 

The Honorable Ken Salazar: 
United States Senate: 

The Honorable Charles E. Schumer: 
United States Senate: 

The Honorable Ron Wyden: 
United States Senate: 

The Honorable Carolyn B. Maloney: 
House of Representatives: 

(360752): 

FOOTNOTES 

[1] Kerr-McGee Oil and Gas Corp. v. Burton, No. CV06-0439LC (W.D. La. 
March 17, 2006). 

[2] Oil and Gas Royalties: Royalty Relief Will Likely Cost the 
Government Billions, but the Final Costs Have Yet to Be Determined, GAO-
07-369T (Washington, D.C.: January 18, 2007). 

[3] One barrel of oil equivalent (BOE) equals one barrel of oil or 5.62 
thousand cubic feet of natural gas. 

[4] As oil and gas reserves are developed and more knowledge of the 
field is obtained, proven reserves generally experience some growth. 

[5] These scenarios are not probabilistic estimates of what may 
actually happen with royalty revenue. Rather, they are illustrative 
examples using estimates of future oil and natural gas production that 
we believe are reasonable based on the history of leases in the Gulf of 
Mexico and using oil and gas prices that are within the range of prices 
that have existed in the past three years. As such, we believe the 
scenarios are reflective of plausible possibilities, but we do not 
assign any probabilities to any of the scenarios. 

[6] The royalty rate for DWRRA leases in less than 400 meters of water 
is 16.67 percent, and the royalty rate for leases in waters greater 
than 400 meters is 12.5 percent. 

[7] It should be noted that if oil prices were to fall and remain at 
$36 per barrel or below and natural gas prices at $4.50 per thousand 
cubic feet or below, no royalties would be due even if the price 
thresholds that were imposed on the 1996, 1997, and 2000 leases were 
applied to the 1998 and 1999 leases. 

[8] Future foregone royalties are dependent on the "royalty suspension 
volume." Royalty suspension volumes are cumulative production amounts 
above which royalty relief no longer applies. 

[9] Total lease numbers for 1998 and 1999 leases do not add to 1,032 
due to overlapping time periods. 

[10] In some of our scenarios, oil and gas prices drop below price 
thresholds in the latter years of the producing lives of the leases. In 
these cases, this royalty revenue is not considered forgone royalties.

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