Offshore Oil and Gas: Opportunities Exist to Better Ensure a Fair Return on Federal Resources
Fast Facts
Production of oil and natural gas in federal waters generated about $90 billion in revenue for the government from 2006 through 2018. The Bureau of Ocean Energy Management leases exploration rights to companies and sets royalty rates on production.
We found the bureau systematically underestimates the value of offshore oil and gas leases, resulting in the government collecting hundreds of millions of dollars less than it otherwise could.
We recommended ways the bureau could better ensure receipt of fair market value for these leases.
Management of federal oil and gas resources is a topic on our High Risk List.
Offshore platform
Highlights
What GAO Found
GAO's analysis indicates that changes in the price of oil and in royalty rates drive changes in the amount companies in the offshore oil and gas industry bid for leases (the amount paid upfront at auction for the right to explore and develop offshore tracts of land). Specifically, between May 1985 and June 2018, peaks in industry bidding coincided with higher oil prices. Additionally, when the Department of the Interior's (Interior) Bureau of Ocean Energy Management (BOEM) offered leases at lower royalty rates, industry bid somewhat higher amounts per acre. For example, certain leases were sold from 1996 through 2000 with no royalties on initial volumes of production, which GAO estimates resulted in BOEM collecting, at most, nearly $2 billion in additional bid revenue. However, bureau estimates indicate these leases resulted in about $18 billion in foregone royalties through 2018.
BOEM's valuation process might not fully assure receipt of fair market value, based on GAO's analysis of BOEM data. BOEM develops valuations for offshore tracts it assesses to be economically viable—assessments of their fair market value—and awards leases so long as the bid is greater than or equal to BOEM's valuation. BOEM's valuations for tracts were generally low relative to industry bids because, according to BOEM officials, they conservatively forecast to account for inherent uncertainties in, among other things, the quantity of oil and gas present as well as exploration and development costs. In addition, GAO identified two ways BOEM's valuation process results in lowering its already conservative valuations that might not fully assure receipt of fair market value:
Unreasonably high depreciation. BOEM forecast that tracts would lose a median of 23 percent of their value in between sales, leading the bureau to accept lower bids because it determined the tracts might be worth even less in the future. Bureau officials told GAO that lower future values are generally due to BOEM discounting the delayed collection of revenue. However, BOEM's forecasted depreciation increased even though tracts are now available twice as frequently as they were prior to August 2017, reducing the time for discounting. Officials said they were unaware of the high rates and the issue warrants further examination. Enlisting a third party to examine the extent to which the bureau's use of delayed valuations assures the receipt of fair market value, and making changes as appropriate, would help BOEM mitigate risks of continuing to accept bids based on poor information on tracts' future values.
Lowered valuations. BOEM officials told GAO that they lower some initial valuations that are “slightly above” industry's bids and which would therefore be rejected per procedures to assure fair market value. Officials said they prefer to accept bids unless there is high certainty that the bids are inadequate. However, GAO identified bias, or statistical anomalies, where BOEM lowered many valuations that were initially higher than industry's bids. Specifically, from March 2000 through June 2018, BOEM rejected 27 bids for tracts that it ultimately valued at up to double industry's bid whereas it accepted 359 bids in which industry's bid was up to double BOEM's valuation. Tracts for rejected bids are, on average, subsequently sold for more than twice the initial rejected amount, suggesting that BOEM could be forgoing hundreds of millions of dollars in bid revenue by accepting bids that are too low.
Why GAO Did This Study
Production of oil and natural gas from offshore leases is a significant source of federal revenue, totaling almost $90 billion from 2006 through 2018. BOEM is required to seek a fair return from offshore leasing and production activities in federal waters. Companies generally pay (1) bids for leases for the right to develop tracts, (2) rents on leased but undeveloped tracts, and (3) royalties on revenues from the sale of oil and gas produced from leases. BOEM holds auctions to award leases to the company offering the highest bid so long as the bureau determines the bid represents fair market value.
GAO was asked to examine issues related to offshore federal oil and gas leasing. This report, among other objectives, (1) describes the effect of oil prices and royalty rates on industry bids for leases and (2) examines the extent to which BOEM's valuation process assures receipt of fair market value. GAO reviewed laws, policies, and regulations; interviewed BOEM officials; and developed an empirical model using BOEM data to analyze the effect of royalty rates and other factors on industry bidding.
Recommendations
GAO is making four recommendations, including that BOEM (1) enlist an independent third party to examine whether the use of delayed valuations assures the receipt of fair market value and (2) take steps to ensure its bid valuation process is not biased toward lowering valuations. Interior disagreed with the first and partially agreed with the second, disagreeing with GAO's characterization of BOEM's process. GAO maintains the recommendations are valid as discussed in the report.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Bureau of Ocean Energy Management | The BOEM director should develop a documented plan for determining whether and how to develop a progressive royalty structure that clearly defines what is to be achieved, who is to achieve it, how it will be achieved, and the time frames for achievement. (Recommendation 1) |
In January 2021, Interior indicated that BOEM has evaluated and considered whether and how to develop a progressive royalty structure, specifically a price-based royalty structure, and determined reductions at low prices would have only marginal impact. Given current market conditions and outlook, BOEM does not believe this is an appropriate time to implement policies aimed at higher price scenarios. In June 2021, BOEM reassessed and considered the benefits and complexities of a price-based royalty and determined not to proceed with its implementation.
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| Bureau of Ocean Energy Management | The BOEM director should enlist an independent third party to examine the extent to which the bureau's use of delayed valuations assures the receipt of fair market value, and make changes—such as terminating the use of delayed valuations or amending its model's assumptions—as appropriate. (Recommendation 2) |
Interior did not agree with this recommendation. Specifically, Interior stated BOEM did not agree with our characterization of BOEM's delayed valuations and stated that BOEM believes it is neither necessary nor cost effective to enlist an independent third party. However, BOEM agreed to (1) examine its delayed value calculation, particularly as it relates to the impact of biannual lease sales, (2) develop a plan to perform a comprehensive internal review of delayed value calculations and make appropriate changes, and (3) institute a peer-review process for all potential changes. Based on work conducted by an internal multidisciplinary team and a separate peer review team, in March 2022, the BOEM Director issued a memorandum discontinuing the use of delayed valuations for assessing the fair market value of bids. BOEM intends to replace delayed valuations with the "lower bound confidence interval," a statistical concept to capture the lower bound of a range of values encompassing the true unknown mean of the risked present worth of the resources at the time of the lease sale. In January 2023, BOEM issued a notice in the Federal Register inviting public comment on proposed changes to its bid adequacy procedures, which include the discontinuation of the use of delayed valuations in favor of a statistical lower bound confidence interval. In August 2023, BOEM indicated that it has finalized its revised bid adequacy procedures and will implement them in lease sales included in the next National Outer Continental Shelf Oil and Gas Leasing Program.
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| Bureau of Ocean Energy Management | The BOEM director should take steps to ensure that BOEM's bid valuation process is not biased toward adjusting valuations downward based on their proximity to bids. (Recommendation 3) |
Interior partially agreed with this recommendation. Specifically, Interior stated it agreed with the recommendation, but did not agree with our characterization of BOEM's bid valuation process. In August 2023, BOEM provided documentation to GAO demonstrating that it had identified, documented, and remediated deficiencies with its bid evaluation process. Specifically, BOEM reviewed its fair market value procedures and identified several areas where bias may occur and will implement procedural improvements to ensure bias is further reduced and evaluations are focused on the analysis of geologic, engineering, and economic variables-rather than the value of industry bids-in lease sales included in the next National Outer Continental Shelf Oil and Gas Leasing Program.
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| Bureau of Ocean Energy Management | The BOEM director should implement a systematic process for comprehensively evaluating its tract valuations, such as by expanding the scope of the bureau's "lookback studies" effort, and remediating any identified deficiencies. (Recommendation 4) |
Interior partially agreed with this recommendation. Specifically, Interior stated it agreed with the recommendation, but did not agree with our characterization of BOEM's bid tract evaluation process and review procedures. In January 2021, Interior amended its position, agreed with the recommendation, and indicated that BOEM will implement a systematic process to comprehensively evaluate tract valuations and conduct a comprehensive review of its oil and gas tract valuation and "lookback" procedures. In August 2023, BOEM provided documentation to GAO demonstrating that it had done so and that it will implement its changes in lease sales included in the next National Outer Continental Shelf Oil and Gas Leasing Program.
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