While most companies that lease federal lands pay their royalties in cash, the federal government can instead take a portion of the oil and gas that these companies produce—known as “taking royalties in kind.” The Congress authorized royalties in kind under the Mineral Leasing Act of 1920 and under the Outer Continental Shelf Lands Act of 1953. Standard leases for the exploration of oil and gas on federal properties reserve the right for the federal government to take its royalties in kind. MMS Has Taken Increasing Amounts of Royalties in Kind Since 1995 to Meet Several Objectives

From January 1995 through September 2001, MMS took 178 million barrels of oil and 213 billion cubic feet of gas in kind primarily for three purposes: (1) to provide small refiners with a stable source of crude oil, (2) to fill the Strategic Petroleum Reserve (SPR), and (3) to study alternatives to the traditional system of cash royalty payments. MMS Takes Oil in Kind and Sells It to Small Refiners

From January 1995 through September 2001, MMS sold to small refiners about 143 million barrels of oil, or about 25 percent of the federal government’s royalty share of all oil produced on federal lands during this time period. This amount represented about 17 percent of the federal government’s royalty share of all oil produced on federal lands in each of these 2 years, as shown in figure 1. However, MMS has yet to develop several key management control activities and does not plan to develop them until 2004, when it will consider the RIK Program to have changed from a pilot status to a fully operational status. MMS Has Begun to Establish Management Control

MMS has begun to establish management control over its RIK Program by addressing the risk that oil and gas sales will be unsuccessful, addressing inherent risks associated with the sale of oil and gas, and developing written procedures for various activities within the Royalty-in-Kind Program. MMS also has made progress in documenting the results of its RIK sales. However, MMS has not established clear objectives for the program that are linked to statutory requirements. In addition to the lack of objectives linked to statutory requirements, MMS is not systematically collecting the necessary information to monitor and evaluate the RIK program. Without clear objectives and the systematic collection of evaluative information, MMS cannot assess and ultimately determine whether it should expand or contract the use of royalty in kind sales. Recommendations for Executive Action

To continue the further development of management control for the Minerals Management Service’s Royalty-in-Kind Program, we recommend that the Secretary of the Interior instruct the appropriate managers within the Minerals Management Service to do the following:  Clarify the Royalty-in-Kind Program’s strategic objectives to explicitly state that goals of the Royalty-in-Kind pilots include obtaining fair market value and collecting at least as much revenue as MMS would have collected in cash royalty payments. 5. 6. 7.
Why GAO Did This Study

In fiscal year 2001, the federal government collected $7.5 billion in royalties from the sale of oil and gas produced on federal lands. Although most oil and gas companies pay royalties in cash, the Department of the Interior's Minerals Management Service (MMS) has the option to take a percentage of the oil and gas produced and either transfer this percentage to other federal agencies or to sell this percentage itself--known as "taking royalties in kind." GAO reviewed the extent to which MMS has taken royalties in kind since 1995, the reasons for taking royalties in kind, and MMS's progress in implementing management control over its Royalty-in-Kind Program.

What GAO Found

From January 1995 through September 2001, the Minerals Management Service (MMS) took, in kind, 178 million barrels of oil and 213 billion cubic feet of gas, or 32 percent of the federal government's royalty share of all oil and 3 percent of the federal government's royalty share of all gas produced on federal lands. MMS sold the majority of this oil--143 million barrels--to small refiners in accordance with long-standing legislation. MMS also took 29 million barrels of federal royalty oil to fill the Strategic Petroleum Reserve. MMS took the remaining 6 million barrels of oil in kind and all the gas in kind under a series of pilot projects to evaluate whether there are additional circumstances under which taking royalties in kind is in the best interest of the federal government. MMS personnel have made progress in implementing some components of management control for its Royalty-in-Kind Program, such as addressing the risks associated with oil and gas sales and developing written procedures. However, MMS does not plan to complete and implement all management controls until 2004, when it will consider the Royalty-in-Kind pilots to have changed from a pilot stage to a fully operational stage and when it will have acquired additional systems support. To date, MMS has not developed clear strategic objectives linked to statutory requirements nor collected the necessary information to effectively monitor and evaluate the Royalty-in-Kind Program. Without clear objectives linked to statutory requirements and the collection of necessary information, MMS cannot systematically assess whether Royalty-in-Kind sales are administratively less costly, whether they generate fair market value or at least as much revenue as traditional cash royalty, payments, and thus whether MMS should expand or contract the Royalty-in-Kind Program.