type: other

jurisdiction: US

text: b'U.S. Department of the Interior\nOffice of Inspector General\n\n\n\n\n EVALUATION REPORT\n\n ;_ ----\n OPPORTUNITY TO INCREASE\n OFFSHORE OIL AND GAS\n RENTAL REVENUES,\n MINERALS MANAGEMENT SERVICE\n\n REPORT NO. 99-I-387\n MARCH 1999\n\x0c I-IN-MMS-002-98-A\n\n\n United States Department of the Interior\n OFFICE OF INSPECTOR GENERAL\n Washington. D.C. 20240\n\n\n\n MAR 31 1993\n\n\n\n\n EVALUATION REPORT\nMemorandum\n\nTo: Assistant Secretary for Land and Minerals Management\n .- :.\nFrom: Robert J. Williams\xe2\x80\x99 \xe2\x80\x99\n Assistant Inspector General for\n\nSubject: Evaluation Report on Opportunity To Increase Offshore Oil and Gas Rental\n Revenues, Minerals Management Service (No. 99-I-387)\n\n INTRODUCTION\nThis report presents the results of our evaluation of potential increases in revenues for certain\nleases subject to the Deep Water Royalty Relief Act of 1995 (Public Law 104-58). During\nthe followup evaluation of our December 1993 audit report \xe2\x80\x9cOffshore Minerals Leasing\nActivities, Minerals Management Service\xe2\x80\x9d (No. 94-I-l 79), we noted that the Minerals\nManagement Service has an opportunity to significantly increase rental revenues fi-om certain\noffshore oil and gas leases. The objective of this evaluation was to provide information to\nService management on laws, regulations, policies, and procedures relating to the\nopportunity to increase revenues and an estimate of the amount of revenues that may be\nrealized by this opportunity.\n\nBACKGROUND\n\nThe Minerals Management Service\xe2\x80\x99s mission includes managing the Offshore Minerals\nLeasing Program under the provisions of the Outer Continental Shelf Lands Act, as\namended. To accomplish this part of its mission, the Service prepares oil and gas leasing\nschedules, holds lease sales on offshore tracts (up to 5,760 acres), and awards leases on\noffshore Federal lands to the highest qualified bidder. For each lease awarded, the Service\nreceives revenues in the form of bonus bids, rental fees, and royalties if a lessee begins\nproduction of oil and gas on the leased tracts. Bonus bids are a one-time cash amount paid\nper acre to the Service by the highest qualified bidders on leases they obtain. Rental fees are\nannual payments based on a fixed dollar amount per acre established at the time a lease is\n\x0cissued. Lessees make royalty payments equal to a stated share or percentage of the value of\nthe oil or gas produced on a tract. During calendar years 1997 and 1998, rent and royalty\nrevenues from the Outer Continental Shelf oil and gas leases totaled about $6.9 billion,\nwhich consisted of royalties of about $6.4 billion and rents of $467 million.\n\nSCOPE OF EVALUATION\n\nThe evaluation was conducted at the Service\xe2\x80\x99s Economics Division in Herndon, Virginia.\nAs part of the evaluation, we reviewed laws, regulations, and records pertaining to the\nService\xe2\x80\x99s offshore oil and gas leasing program and interviewed Service personnel\nresponsible for administering the program. We also reviewed the Secretary\xe2\x80\x99s Annual\nStatement and Report to the President and the Congress for fiscal year 1995, which was\nrequired by the Federal Managers\xe2\x80\x99 Financial Integrity Act; the Departmental Reports on\nAccountability for fiscal years 1996 and 1997, which include information required by the\nAct; and the Service\xe2\x80\x99sannual assurance statement on management controls_-... _ .for fiscal year\n1997. Based on our review, we determined that no material weaknesses were included in\nthese documents that directly related to the objective and scope of our evaluation.\nFurthermore, we evaluated the system of internal controls to the extent that they related to\nthe objective and scope of the evaluation. _ We did not identify any internal control\nweaknesses. Instead, we identified an opportunity for the Minerals Management Service to\nincrease oil and gas lease rental fee revenues. The evaluation was conducted in accordance\nwith the \xe2\x80\x9cQuality Standards for Inspections,\xe2\x80\x9d issued by the President\xe2\x80\x99s Council on Integrity\nand Efficiency. Accordingly, we included such tests of records and other evaluation\nprocedures that were considered necessary to accomplish our stated objective.\n\nPRIOR AUDIT COVERAGE\n\nIn our December 1993 audit report \xe2\x80\x9cOffshore Minerals Leasing Activities, Minerals\nManagement Service\xe2\x80\x9d (No.94-I-179), we found that the Service charged rates for bonus bids\nof $25 per acre and for rental fees of $3 per acre, which were less than the $32.50 and the\n$5 per acre rates, respectively, recommended in its internal studies, even though the Outer\nContinental Shelf Lands Act, as amended, requires that the Government receive fair market\nvalue for leases.\n\nOur prior report included a recommendation that the Service should establish a procedure\nwhich would require both the minimum bonus bid and the rental fee rates to be evaluated\nbefore each offshore oil and gas lease sale and require the rates to be increased, as\nappropriate, based on the evaluation. The Service concurred with the recommendation,\nstating that it believed that \xe2\x80\x9cperiodic evaluation of the effects of minimum bids and rental\nrates on Government receipts as well as other leasing objectives is clearly in the public\ninterest.\xe2\x80\x9d\n\nIn our March 1998 evaluation report \xe2\x80\x9cFollow up of Offshore Minerals Leasing Activities,\nMinerals Management Service\xe2\x80\x9d (No. 98-I-385) we found that the Service had taken action\nto implement the recommendation made in our December 1993 audit report. As a result, we\n\n 2\n\x0cdetermined that the increased rental fees for offshore oil and gas leases issued from\nSeptember 1993 to August 1997 had generated an estimated $141 million in additional\nFederal revenues between calendar years 1993 and 1997 and were expected to generate an\nadditional $194 million for these same leases during the 4-year period of 1998 to 2001.\n\n RESULTS OF EVALUATION\nWe found that the Minerals Management Service has an opportunity to increase rental fee\nrevenues. Specifically, the Deep Water Royalty Relief Act allows for royalty payments to\nbe suspended for up to 87.5 million barrels of oil equivalent\xe2\x80\x99 produced under offshore leases\nin deep water (considered by the Royalty Relief Act to be water depths of 200 meters or\nmore) primarily in the central and western portions of the Gulf of Mexico. During the period\nwhen royalty payments are suspended, the Service\xe2\x80\x99s offshore oil and gas lease terminates\nrental fees. Thus, the Department of the Interior does not receive any revenues during the\n .\nperiod when royalties are suspended for offshore leases, This is in contrast to the terms of __ ..-\nonshore leases, which require payments to be equal to the higher of rental fees or royalties -. \xe2\x80\x98.\nthroughout the time period of the lease. Based on our review, we estimated that the\nGovernment has lost the potential to earn rental revenues of as much as $3.7 million\nassociated with deep water leases issued prior to the Royalty Relief Act and has lost the\npotential to earn rental revenues ranging from $6.9 million to $75.9 million on oil and gas\nleases issued in 1996 and 1997, subsequent to the Royalty Relief Act. However, the Service\nhas an opportunity to increase rental revenues by an estimated $2.4 million to $26 million\nfor leases that will be issued between April 1, 1999, and December 3 1,2000, by changing\nthe terms of these leases before they are sold to require rental payments during periods of\nroyalty relief.\n\nThe Deep Water Royalty Relief Act\n\nIn November 1995, the Outer Continental Shelf Lands Act was amended by Public Law\n104-58, Title III (the Deep Water Royalty Relief Act). The amendment requires that new\ndeep water leases in the central, western, and a small portion of the eastern Gulf of Mexico\nissued within 5 years of the date of the amendment be offered with a provision suspending\nroyalties on a specified number of barrels of production, depending on water depth. In\naccordance with the Deep Water Royalty Relief Act, the minimum royalty suspension\nvolumes are as follows:\n\n - 17.5 million barrels of oil equivalent for leases in water depths of 200 to 400 meters.\n\n - 52.5 million barrels of oil equivalent for leases in water depths of 400 to 800 meters.\n\n\n\n\xe2\x80\x98The Minerals Management Service defines \xe2\x80\x9cbarrel of oil equivalent\xe2\x80\x9d as follows: \xe2\x80\x9cThe amount of energy\nresource (m this document, natural gas) that is equal to one barrel of oil on an energy basis. The conversion\nis based on the assumption that a barrel of oil produces the same amount of energy when burned as 5,620 m3\nof natural gas.\xe2\x80\x9d\n\n 3\n\x0c - 87.5 million barrels of oil equivalent for leases in water depths of more than 800\nmeters.\n\nThe purposes of the Deep Water Royalty Relief Act were to (1) promote development or\nincrease production on the Gulf of Mexico\xe2\x80\x99s Outer Continental Shelf or (2) encourage\nproduction ofmarginal resources on producing or nonproducing leases in deep water. While\ndeep water leases issued before November 1995 are not automatically covered by the Act,\nroyalty relief for production under these leases would be available if the lessee requested and\nthe Secretary of the Interior determined that new production under these leases might not be\neconomical in the absence of relief.\n\nCurrent Lease Terms\n\nThe Code of Federal Regulations (43 CFR 3 103.2-2) states that rental payments for onshore\noil and gas leases \xe2\x80\x9cshall not be due on acreage for which royalty or minimum royalty is being\npaid.\xe2\x80\x9d (The Code defines \xe2\x80\x9cminimum royalty\xe2\x80\x9d as the.equivalent ofthe yearly rental charges.) :__\xe2\x80\x98..\xe2\x80\x98_\nThus, annual rental fees are required to be paid on onshore leases until royalties are paid in\nan amount that exceeds the annual rental fees. In contrast, the Service\xe2\x80\x99s offshore oil and gas\nlease form in use since at least 1986 states, with regard to rent, that \xe2\x80\x9cthe Lessee shall pay the\nLessor, on or before the first day of each lease year which commences prior to a discovery\n 2\nin paying quantities of oil or gas on the leased area, a rental as shown on the face hereof.\xe2\x80\x9d\nConsequently, rental fees are not paid once a leased tract begins to produce oil or gas. In\naddition, the offshore leases issued since the Royalty Relief Act automatically provide\nroyalty relief for leases issued in oil fields previously approved by the Service as being\neligible for royalty relief. Thus, eligible leases automatically provide relief from rental and\nroyalty payments for up to 87.5 million barrels of oil, whereas onshore leases require the\npayment of rent until annual royalties exceed the annual rental due on a lease. A senior-\nlevel Service official stated that the Service was aware that the offshore lease prepared in\nresponse to the Royalty Relief Act would eliminate rent fees during periods of royalty relief.\n\nEstimate of Impact on Rental Revenues\nWe estimated that the Government has lost the potential to earn rental revenues of as much\nas $3.7 million on deep water leases issued prior to the Royalty Relief Act and has lost the\npotential to earn revenues ranging from $6.9 million to $75.9 million for oil and gas leases\nissued in 1996 and 1997, which was subsequent to the Royalty Relief Act. However, the\nService has an opportunity to increase rental revenues by an estimated $2.4 million to\n$26 million for leases that will be issued between April 1,1999, and December 3 1,2000, by\nchanging the terms of these leases before they are sold to require rental payments during\nperiods of royalty relief. The details regarding our approach to estimating these impacts are\nas follows:\n\n\n\xe2\x80\x98\xe2\x80\x9cPaying quantities\xe2\x80\x9d is defined in the Code of Federal Regulations (30 CFR 250.111) as the \xe2\x80\x9cproduction of oil,\ngas, or both in quantities sufficient to yield a return in excess of the costs, after completion of the well, of\nproducing the hydrocarbons at the wellhead.\xe2\x80\x9d\n\n 4\n\x0c Pre-Royalty Relief Act Leases. The Service told us that it expects 23 nonproducing\ndeep water oil and gas leases issued prior to the Royalty Relief Act to be producing by 2002\nand that royalties for these leases could be suspended under the Act ifthe lessees request and\nthe Secretary approves the requests. If all 23 lessees were approved for royalty relief, we\nestimated that the Service has lost the potential to earn as much as $3.7 million in rental fee\nrevenues because the Department\xe2\x80\x99s offshore leases do not require rental fees during periods\nof royalty relief. The revenues of $3.7 million were calculated as follows: 23 leases\nmultiplied by 5,380 acres (average lease size) multiplied by $7.50 per acre rental fee\nmultiplied by 4 years. 3 However, we recognize that it is possible that none of these leases\nwill be approved for royalty relief and, in that case, no rental revenues would be lost.\n\n Post-Royalty Relief Act Leases. Because of the large number of leases covered by\nthe Deep Water Royalty Relief Act and the increase in the per acre rental charge from $3.00\nto $7.50, the loss of rental fees paid to the Department could be significant for leases issued\nafter the Royalty Relief Act. We estimated that the Service has lost the potential to earn\nrevenues ranging from $6.9 million to $75.9 million. To derive this estimate, we requested ._ ~._._\nthat the Service determine the number and percentage of existing deep water leases issued\nafter the Royalty Relief Act which were producing and the number and percentage of\nnonproducing leases it expected to produce in the future. We also requested an estimate of\nthe average time expected for an oil and gas well to attain production that exceeded the\nsuspension volumes included in the Act.\n\nIn its response to our requests, the Service stated that as of June 1998,2 to 5 percent of the\nleases in deep water were producing. It further stated that there were no leases producing in\nwater depths exceeding 400 meters. In addition, we found that the most current issue of the\nMinerals Management Service\xe2\x80\x99s publication \xe2\x80\x9cOffshore Stats\xe2\x80\x9d for the third and fourth quarters\nof 1997 stated that about 22 percent of existing offshore leases were producing. Although\nmost of these producing leases were in water depths of 200 meters or less, we noted that the\noil and gas industry experts were reporting that improvements in offshore exploration and\ndrilling technologies had greatly lowered the costs to produce oil and gas in water depths of\nmore than 200 meters and that the prospect of increased production for leases in this area was\nhigher than in the past. Also, the Department of Energy, which maintains statistics on energy\nproduction and consumption, reported that because of the lower costs, oil and gas production\nin deep water was increasing.\n\nDuring our evaluation, Service officials said that they recognized that their experience with\nproduction in water exceeding 200 meters was limited and that deep water oil and gas\nproduction costs were declining. They suggested that a reasonable estimate of the potential\nincreased rental revenues be based on a production rate ranging from 2 to 22 percent of the\n2,138 leases entered into since the effective date of the Act. Service officials estimated that\nit would take almost 4 years for a tract to produce oil or gas above the royalty suspension\nvolumes. The estimate of lost revenues of $6.9 million was calculated by multiplying 43\n\n\n\xe2\x80\x98This is the average period of time that the Service estimated it would take for a lessee to reach the royalty\nsuspension volume and to begin paying royalties.\n\n 5\n\x0cleases (2 percent of 2,138 leases) by 5,380 acres (average lease size) multiplied by the $7.50\nper acre rental fee multiplied by the 4-year average period of suspended royalties. The\nestimate of lost revenues of $75.9 million was calculated by multiplying 470 leases (22\npercent of 2,138 leases) by 5,380 acres (average lease size) multiplied by the $7.50 per acre\nrental fee multiplied by the 4-year average period of suspended royalties.\n\nIn addition to these leases, the Service advised us that it anticipates deep water lease sales\nof 3.9 million acres between April 1,1999, and December 3 1,2000, when the Royalty Relief\nAct is due to expire. By revising the lease terms to require annual rental fee payments during\nperiods of royalty suspension, we believe that the Service has the potential to earn revenues\nestimated at between $2.4 million and $26 million from these leases. This estimate was\ncalculated by multiplying .08 million acres (2 percent of 3.9 million acres) and .86 million\nacres (22 percent of 3.9 million acres) by the $7.50 per acre rental fee multiplied by the\n4-year average period of suspended royalties.\n\nWe believe that the Service, to realize those potential rental revenues, should revise its oil\nand gas leases before the sales are executed to continue annual rental fee payments during\nperiods of royalty suspension. In that regard, our General Counsel, in a November 20,1998,\nmemorandum, noted that the United States Code (43 U.S.C. 1337(b)(6)) states that oil and\ngas leases \xe2\x80\x9cshall contain such rental and other provisions as the Secretary may prescribe at\nthe time of offering the area for lease.\xe2\x80\x9d Also, the General Counsel stated that the Service\nshould determine whether it has the authority to revise existing leases to require such\npayments before the lessees are granted royalty relief to preclude new lessees from paying\nrental fees while existing lessees are not required to pay royalties or rental fees.\n\nRecommendations\n\nWe recommend that the Director, Minerals Management Service:\n\n 1. Ensure that offshore oil and gas leases which will be issued in the future under the\nprovisions of the Deep Water Royalty Relief Act of 1995 require that annual rental fee\npayments continue during royalty suspension periods until royalty payments meet or exceed\nthe annual rental fees for leased tracts covered by the Act.\n\n 2. Request a Solicitor\xe2\x80\x99s opinion as to whether the Service has authority to modify\nterms of existing leases to require rental payments of lessees during royalty suspension\nperiods. If this authority does not exist, the Service should request a Solicitor\xe2\x80\x99s opinion as\nto whether legislation can be sought to remedy this situation.\n\nMinerals Management Service Response and Office of Inspector General\nReply\nIn the October 7, 1999, response (Appendix 2) to our draft report from the Director,\nMinerals Management Service, the Service nonconcurred with both recommendations but\nstated that it would consider the report\xe2\x80\x99s recommendations as it begins discussions of\n\n 6\n\x0cwhether the financial terms for deep water leases should be changed for future lease sales.\nBased on the response, we have revised the recommendations to clarify our intent. However,\nwe consider the Service\xe2\x80\x99s comments to be partially responsive to both recommendations (see\nAppendix 3).\n\nRecommendation 1. Nonconcurrence\n\nIn commenting on the report, the Service said that Recommendation 1 applied to future\nleases issued under the provisions of the Royalty Relief Act; however, it questioned whether\nthe recommendation applied to leases which existed prior to the Act. We revised the\nrecommendation to clarify that it applied only to future leases. The Service also stated that\nthe Assistant Secretary for Land and Minerals Management had issued a notice in the\nFederal Register and hosted a workshop in June 1998 to begin discussions of whether the\nfinancial terms for deep water leases should be changed for future lease sales and that it\nwould consider the report\xe2\x80\x99s recommendations during its review.\n\nRecommendation 2. Nonconcurrence\n\nThe Service said that Recommendation 2 applied to leases which were issued prior to and\nafter the Royalty Relief Act, stating that it could not \xe2\x80\x9cunilaterally change\xe2\x80\x9d leases already\nissued, that a number of leases were already producing and were not eligible for royalty\nrelief, and that lessees who hold leases issued after the Royalty ReliefAct do not require that\nthe Service approve royalty relief. The Service said that it therefore had \xe2\x80\x9cno leverage on\nwhich to rely in negotiating changes to lease terms.\xe2\x80\x9d\n\nBased on these comments, we have revised Recommendation 2 to clarify that the Service\nshould seek a Solicitor\xe2\x80\x99s opinion regarding whether there is authority for the Service to\nmodify lease terms to require rental payments of lessees during royalty suspension periods\nand, if such authority is lacking, whether legislation can be sought to remedy this situation.\n\nAdditional Comments on Report\n\nThe Service also made other comments regarding our recommendations and our estimates\nofpotential increased revenues. The Service\xe2\x80\x99s comments and our replies to these comments\nare in the paragraphs that follow.\n\nThe Service commented that the statement in our August 1997 draft report that Service\nofficials \xe2\x80\x9cgenerally concurred\xe2\x80\x9d with the report\xe2\x80\x99s recommendations during our June 2, 1998,\nexit conference is \xe2\x80\x9cincorrect.\xe2\x80\x9d We included this statement based on the Service\xe2\x80\x99s comments\nat the exit conference that it agreed with the report\xe2\x80\x99s conclusions that under the terms of the\nService\xe2\x80\x99s offshore oil and gas leases, the Department would not receive rental revenues\nduring periods of royalty relief and that it would pursue implementing our recommendations.\nHowever, the Service advised us that implementation may be difficult since the July 8,1998,\nDepartment of the Interior appropriations bill for fiscal year 1999 (H.R. 105609) included\n\n\n\n 7\n\x0ca statement that restricted it from making changes to the financial terms of the oil and gas\nleases. Specifically, the appropriations bill stated the following:\n\n It has come to the attention of the Committee [on Appropriations] that MMS\n [Minerals Management Service] is proposing a public workshop to look at\n whether modifications to deep water leases are warranted. The Committee\n expects that existing financial terms for these lease sales will be maintained\n until this workshop is completed, public comments fully analyzed, and a\n report provided to the House and Senate Committees on Appropriations.\n\nWhile this language restricts the Service from making changes to the financial terms of the\nleases until certain actions are completed, it does not prohibit the Service Tom making such\nchanges. Also, the Service stated that it would pursue implementation of the report\xe2\x80\x99s\nrecommendations, which we interpreted to mean that the Service \xe2\x80\x9cgenerally concurred\xe2\x80\x9d with\nthe intent of the recommendations.\n\nThe Service stated that increasing rental fees could reduce offshore oil and gas lease sales\nand revenues from bonus bids on these leases. In response to a recommendation in our\nDecember 1993 audit report \xe2\x80\x9cOffshore Minerals Leasing Activities, Minerals Management\nService,\xe2\x80\x9d the Service also commented that lease sales and revenues from bonus bids would\ndecline. However, our March 1998 evaluation report \xe2\x80\x9cFollowup of Offshore Minerals\nLeasing Activities, Minerals Management Service\xe2\x80\x9d noted that the Service increased the rental\nrates on offshore oil and gas leases from $3 per acre to $7.50 per acre and realized increased\nrental revenues of $141 million between September 1993 and August 1997, with expected\nadditional rental revenues of $194 million between fiscal years 1998 and 2001. Also, the\nminimum bid rates did not decline after the rental rate was increased to $7.50 per acre but\nremained at $25 per acre, which is the same rate that had been in effect for more than 50\nyears.\n\nThe Service stated that our report had \xe2\x80\x9coverestimate[d]\xe2\x80\x9d the $6.9 million to $75.9 million on\ndeep water leases because it could not \xe2\x80\x9cunilaterally change\xe2\x80\x9d leases which it had issued and\nthat companies had bid on leases with the understanding that they would not have to pay rent\nduring a period of royalty relief. The estimated range was suggested by a senior-level\nService official after our exit conference on a preliminary draft of this report. However,\nbased on the Service\xe2\x80\x99s comments to the draft report, we have revised the final report to\nrecognize the range of $6.9 million to $75.9 million as an estimate of rental revenues that\nthe Service has lost the potential to earn because of its offshore lease provisions instead of\nclassifying these amounts as potential additional revenues.\n\nThe Service commented that only 23 of 112 deep water leases existing prior to the Royalty\nRelief Act were eligible to request royalty relief and that the remaining 89 leases were\nproducing in paying quantities and thus ineligible for royalty relief. However, the Code of\nFederal Regulations (30 CFR 203.1) states that the Service is authorized to grant royalty\nrelief in three situations, including granting relief for a producing lease proposing to\n\xe2\x80\x9csignificantly expand production under a Development Operations Coordination Document\n\n\n 8\n\x0c. . . or a supplementary . . . [Document], that Minerals Management Service approved after\nNovember 28, 1995.\xe2\x80\x9d Thus, under these circumstances, the 89 producing leases could\nrequest and be eligible for royalty relief. Notwithstanding this provision, we have revised\nthe estimate for theses leases fi-om $18 million to an estimate of as much as $3.7 million.\n\nIn accordance with the Departmental Manual (360 DM 5.3), we are requesting a written\nresponse to this report by April 30, 1999. The response should provide the information\nrequested in Appendix 3.\n\nThe legislation, as amended, creating the Office of Inspector General requires semiannual\nreporting to the Congress on all audit reports issued, the monetary impact of audit findings\n(Appendix l), actions taken to implement audit recommendations, and identification of each\nsignificant recommendation on which corrective action has not been taken.\n\nWe appreciate the assistance of Office of the Secretary and Bureau personnel in the conduct\nof our evaluation.\n\n\n\n\n 9\n\x0c APPENDIX 1\n\n CLASSIFICATION OF MONETARY AMOUNTS\n\n Potential\n Additional\n Finding Area Revenues\nOpportunity to increase rental $2.4 million to\nrevenues for leases to be issued $26 million\nbetween April 1, 1999, and\nDecember 31,200O\n\n\n\n\n 10\n\x0c AFPENDIX 2\n Page 1 of 3\n\n United States Department of the Interior\n MINERALS MANAGEMENT SERVICE\n Washington, DC 20240\n\n OCT -7 19%\n\nMemorandum\n\nTo: Assistant Inspector General for Audits\n &y\nThrough: Bob Armstrong j?!&AdI* OCT - 9 19$X3\n Assistant Secretary, Land and mera s\n\nFrom: Cynthia Quarter-man f\n Director, Mnerals Mana\n B&, e .\n\nSubject: Evaluation Report on Opportunity to Increase Offshore Oil and Gas Rental\n Revenues, Minerals Management Service (Assignment No. I-IN-MMS-002-\n 98ACD))\n\nWe appreciate the opportunity to comment on the Office of Inspector General draft evaluation\nreport. Before commenting directly on its recommendations, we would like to note two factual\nerrors contained in the report.\n\nFirst, the report\xe2\x80\x99s statement that Minerals Management Service officials generally concurred with\nthe report\xe2\x80\x99s recommendations at a June 2, 1998, exit conference is incorrect. MMS officials did\nnot concur in the recommendations. Rather, they indicated that language in the Conference\nReport for the Department of the Interior\xe2\x80\x99s Fiscal Year 1998 supplemental appropriations\nrestricted MMS from making regulatory changes to the terms of the current Deep Water Royalty\nRelief Program. MMS officials said they would consider implementation of the OIG\nrecommendations when appropriate and if permitted by congressional direction.\n\nSecond, the report overestimates the revenues associated with the recommendations. The report\nestimates additional rental revenues of $6.9 to $75.9 million on deep water leases issued in 1996\nand 1997. However, the Government has no legal authority to unilaterally change lease terms on\nexisting leases, so no additional revenues are possible on these-leases. The report also projects\nthat rental fees of $18 million will be lost if the Department of the Interior approves relief for 112\ndeep water leases issued prior to the Deep Water Royalty Relief Act and does not continue rental\npayments during the rehef period. Currently, 89 of those leases are producing and, consequently,\nare not eligible for royalty relief. Also, it is possible that none of the remaining 23 leases will\napply for or be granted royalty relief. Therefore, the report should indicate that potential rental\nfees from these leases could range from zero to $3.7 million.\n\n\n 11\n\x0c APPENDIX 2\n Page 2 of 3\n\n 2\n\nComments on Recommendations\n\n. Ensure that offshore oil and gas lease terms require that annual rental payments continue\n during royalty suspension periods until royalty payments meet or exceed the annual rental\n fee for leased tracts covered by the Deep Water Royalty Relief Act.\n\nDISAGREE - There are two types of leases to which this recommendation applies:\n\n. leases issued since November 1995 subject to the royalty suspension provisions of the\n DWRRA, and\n\n. leases that will be issued in the future under the provisions of the DW\xe2\x80\x99RR4.\n\nWith respect to the former, we have no legal authority to unilaterally change.lease terms on\nexisting leases. Therefore, this recommendation cannot be implemented for this category of\nleases. Further discussion of existing leases appears in our response to the second\nrecommendation below.\n\nWith respect to the latter category, the implementation of the DWRR4 was developed through\ncomprehensive public and internal processes that considered legislative intent and input from\nconstituents and many parts of the Administration. We believe that the financial terms for deep\nwater leases should not be changed for future lease sales held under the DWRRA without a\nsimilar, careful review. MMS has already started such a review. The Assistant Secretary, Land\nand Minerals Management, issued a Federal Register Notice and hosted a workshop in June\n1998 to begin discussions of whether the financial terms for deep water leases should be changed\nfor future lease sales. We will consider the report\xe2\x80\x99s recommendations concerning rentals as we\nproceed with this process.\n\n. Revise existing offshore oil and gas leases prior to granting the lessees royalty relief to\n require the payment of rental fees during periods of royalty suspension. Legislation\n should be sought to implement this recommendation if necessary.\n\nDISAGREE - The type of leases to which this recommendation is intended to apply is unclear.\nHowever, there are two categories of deep water leases that it may seek to address:\n\n. leases issued after November 1995 that have not yet gone into production, and\n\n. non-producing leases issued prior to 1995 that apply for royalty relief on the basis that the\n proposed production project would be uneconomic at the lease stipulated royalty rate.\n\n\n\n\n 12\n\x0c APPEIDIX 2\n Page 3 of 3\n\n\n 3\n\n With respect to the first category of leases, it should be noted that MMS does not \xe2\x80\x9cgrant\xe2\x80\x9d royalty\n relief to them. In accordance with the DWRRA provisions, the royalty suspension volume is\n incorporated into the lease terms. Lessees do not apply for nor does MMS approve the royalty\n relief; therefore, it has no leverage on which to rely in negotiating changes to lease terms.\n\nIn any case, MMS opposes this recommendation because its implementation would violate the\nintegrity of the bonus bid auction system. That is, h4MS sold these leases under specific terms\nknown to all bidders and received cash bonuses in return based on the bidders\xe2\x80\x99 evaiuation of the\ntracts offered with those terms. Had bidders known that rents would be charged during the\nsuspension period, they would have submitted lower bids and fewer tracts would have been sold.\n\nAttempts by MMS or Congress to revise existing lease terms would raise serious potential breach\nof contract issues and the possibility of extensive litigation. Furthermore, if we were to seek\nretroactively to change the terms of existing leases, we believe that potential bidders would be\nmore likely to bid less and on fewer leases at future sales, more than offsetting any additional\nrental revenues that might be collected.\n\nConsequently, we believe that retroactive changes in terms of existing leases are counter-\nproductive if not illegal, but as stated under the first recommendation, we will continue to\nevaluate prospective changes to lease terms for titure lease sales.\n\nIn the case of the second category of leases, Congress intended to provide economic incentives to\nencourage owners of marginal properties to undertake development and production activities that\nwould not be profitable at lease royalty rates. MMS has written guidelines in accord with\nCongress\xe2\x80\x99 purpose, which permit it to determine financial terms on any non-producing lease\ngranted royalty relief. That determination is made as appropriate on a case-by-case basis.\n\nThe provisions of the current program mandated by the DWRFU will sunset in November 2000.\nMMS already has begun an effort to design a follow-on program. In this process, we will\ncarefully consider the rental issues raised in this report. We believe that these issues can best be\ndealt with in a comprehensive fashion rather than trying to impose new rental terms on existing\ncontractual and financial arrangements.\n\nAgain, thank you for the opportunity to provide comments on the report.\n\n\n\n\n 13\n\x0c APPENDIX 3\n\n\n\n\n STATUS OF EVALUATION REPORT RECOMMENDATIONS\n\n\n Finding/\nRecommendation\n Reference Status Action Required\n\n 1 and 2 Unresolved. Provide responses to the revised\n recommendations stating concurrence or\n nonconcurrence. If concurrence is\n indicated, provide action plans that\n include target dates and titles of the\n officials responsible for implementation.\n If nonconcurrence is indicated, provide\n reasons for the nonconcurrence.\n\n\n\n\n 14\n\x0c ILLEGAL OR WASTEFUL ACTIVITIES\n SHOULD BE REPORTED TO\n THE OFFICE OF INSPECTOR GENERAL\n\n\n Internet/E-Mail Address\n\n www.oig.doi.gov\n\n\n\n Within the Continental United States\n\nU.S. Department of the Interior Our 24-hour\nOffke of Inspector General Telephone HOTLINE \xe2\x80\x99\n1849 C Street, N.W. l-800-424-508 1 or\nMail Stop 5341 (202) 208-5300\nWashington, D.C. 20240\n\n TDD for hearing impaired\n (202) 208-2420 or\n l-800-354-0996\n\n\n Outside the Continental United States\n\n Caribbean Region\n\nU.S. Department of the Interior (703) 235-9221\nOffice of Inspector General\nEastern Division - Investigations\n4040 Fairfax Drive\nSuite 303\nArlington, Virginia 22203\n\n North Pacific Region\n\nU.S. Department of the Interior (67 1) 647-6060\nOffice of Inspector General\nNorth Pacific Region\n415 Chalan San Antonio\nBaltej Pavilion, Suite 306\nTamuning, Guam 96911\n\x0cToll Free Numbers:\n l-800-424-5081\n TDD l-800-354-0996\n\nFTVCommercial Numbers:\n (202) 208-5300\n TDD (202) 208-2420\n\n HOTLINE\n1849 C Street, N.W.\nMail Stop 5341\nWashington, D.C. 20240\n\x0c'