Feds Gone Wild, Part III

Part IPart IIPart III

RIP, RIK? New Bill Would Kill Industry’s Darling

By Rone Tempest and Laton McCartney

For more than a decade, West Virginia Democratic U.S. Rep. Nick Rahall watched powerlessly as the Bush administration and a Republican Congressional majority made Royalty in Kind the main method of collecting oil and gas royalties on federal lands.

Huge sums were at stake. For the federal government, oil and gas royalties are one of the biggest sources of revenue, second only to income taxes.  Energy producing states like Wyoming, with vast tracts of federal land, get 49 percent of federal royalties, which annually account for hundreds of millions of dollars in public funds.

As ranking minority member of the House Resources Committee, Rahall repeatedly called for audits of the controversial RIK program and ordered Government Accountability Office oversight reports, only to be frustrated by incomplete information from the Interior Department agency, Minerals Management Service, that administered the program.  He was still on the sidelines in 2008 when an investigation by the Department of Interior Inspector General uncovered widespread corruption and unethical behavior in the Minerals Management Royalty- in-Kind office in Lakewood, Colorado.

On September 8, Rahall’s turn finally came. Now chairman of the powerful House Resources committee, Rahall authored HB 3534, the Consolidated Land, Energy and Aquatic Resources—or CLEAR—Act of 2009. The bill is intended “to provide greater efficiencies, transparency, returns and accountability in the administration of federal mineral and energy resources.”

The act would consolidate federal minerals management and leasing programs into one entity, the Office of Federal Energy and Minerals Leasing of the Department of the Interior. At present, the Bureau of Land Management handles on-shore leases, and Minerals Management Service leases off-shore sites.

Explaining the need for his bill, Rahall pointed to a new Government Accountability Report on erroneous data entered in Minerals Management Service databases, which may have cost Americans $160 million in oil and gas royalties.

“The CLEAR Act…would eliminate the scandal-ridden Royalty-in-Kind program to help prevent the loss of even more money owed to the American people for the disposition of our public energy resources,” Rahall said in a press release announcing committee hearings on the bill.

The first day of hearings on September 16 features testimony by Interior Secretary Ken Salazar and representatives from the offices of the Interior inspector general and Government Accountability. On September 17, the Resources Committee will hear the perspectives of “a variety of stakeholders.” Of special interest to all is Section 217, “Limitation on Royalty In-Kind Program.” The section amends the Mineral Leasing Act of 1920 to prohibit the Secretary of Interior from conducting a “regular program” to take oil and gas lease royalties in kind.

If passed as written, the bill would instantly undo years of intense oil and gas industry lobbying efforts, often assisted by key Wyoming public officials and partisan activists, to make Royalty in Kind the main means of royalty collection on federal lands and offshore leases. For Wyoming, it would end a four-year-old RIK program for natural gas that in fiscal year 2007-2008 accounted for more than half of the $533 million in federal royalties collected in the state.

On August 14, a month before he introduced his proposed legislation,  Rahall received yet another Government Accountability Office report, “Royalty-in-Kind Program: MMS Does Not Provide Reasonable Assurance It Receives Its Share of Gas, Resulting in Millions in Forgone Revenue.” The title basically says it all, but among the details noted in the report is the observation that in fiscal year 2008, Minerals Management Service collected a more than $12 billion in oil and gas royalties, more than half “in kind”: gas valued at more than $2.4 billion, and oil valued at nearly $4.2 billion.

The report noted that Management Service “estimates” it is owed a net of $21 million, but “cannot calculate the full amount” due because it does not have enough data to see if it has received its full percentage of Royalty-in-Kind gas. The agency’s estimate also does not include interest due on unpaid “gas imbalances” because the agency has not determined when interest begins to accrue on an “imbalance.” An imbalance is the difference between the amount of RIK gas a company owes Minerals Management, and the amount it actually pays.

The Service monitors imbalances on a monthly, rather than daily basis, leaving Minerals Management vulnerable to energy companies’ gaming the system by providing less RIK gas to MMS when prices are high and making up the difference when prices fall. This deprives the government of revenues it could realize by selling gas on days when prices are high.

Ignorance and inadequate training add to the Management Service’s difficulties in running a natural gas marketing outfit. The GAO pointed out that “the agency does not know how companies allocate gas” among those claiming a percentage of production, and RIK gas staff is not trained on industry standards for gas imbalance calculations.

Minerals Management appears to take a soft line on the energy companies with which it does business, failing to enforce deadlines and allowing companies to “negotiate imbalances indefinitely.” The Service does not even compel the companies to document production and deliveries in a consistent format, so that MMS employees spend their time gathering and reformatting data instead of finding and collecting imbalances. Despite years of promises to update information technology, the agency’s system can’t calculate cash settlements or compare different kinds of information. Minerals Management processes more than half of its gas imbalance data by hand.

The report also noted that Minerals Management Service “does not audit gas companies’ production and allocation data, therefore it cannot verify that it is receiving its entitled percentage of gas.” The Service does not audit, according to the report, because it believes its verification procedures are “sufficient.” The report observed that gas companies and “other governments” routinely audit their imbalances and “uncover inaccuracies” that could have lost them money if unchecked.

Wyoming’s state government will join those that audit, as Gov. Dave Freudenthal on September 10 wrote to S. Elizabeth Birnbaum, the Obama administration’s director of Minerals Management Service, requesting “the opportunity” to perform an audit of the 2006-2009 RIK natural gas production in the state, in order to protect “the public’s interest in the management of this nonrenewable public resource.”

Freudenthal asked Michael Geesey, director of the Wyoming Department of Audit, to undertake the audit of the RIK royalty revenues remitted to Wyoming.

The potential demise of an industry’s favorite royalty payment method comes just eight years after oil and gas lobbyists and their allies had firmly established RIK as national policy.

When in 2002 Rejane “Johnnie” Burton became the new director of Minerals Management Service in the Interior Department of George W. Bush, the oil and gas industry dropped its lobbying effort to legislate royalty-in-kind.

This does not mean the industry lost interest in paying federal royalties in “kind”– in oil or gas– instead of in cash. Indeed, expanding in-kind payment programs remained an important part of the industry’s political agenda, a significant entry on the “wish list” industry sent to the Energy Department transition team.  The permanent expansion of Royalty-in-Kind was also a key American Petroleum Institute recommendation to Vice President Dick Cheney’s secret national energy policy group.

But lawmaking was not necessary to achieve this goal. Tacitly adopting the argument that Clinton administration Minerals Management Service Director Cynthia Quarterman had made when resisting blanket imposition of RIK, the new administration proceeded to radically expand the program under the authority granted by the Minerals Leasing Act of 1920.

With the Interior Department now led by a sympathetic secretary, oil-and-gas lawyer Gale Norton; an enthusiastic Land and Minerals Management assistant secretary, industry lawyer Rebecca Watson; and a cooperative Minerals Management Service director, Wyoming’s Burton, royalty-in-kind could expand without further legislative mandate. And so it did, quite quickly.

Minerals Management Service “will consider the Royalty-in-Kind pilots to have changed from a pilot stage to a fully operational stage” in 2004, the Government Accounting Office noted in a January 2003 report. The office also said that the pilots, begun in the Gulf of Mexico and in Wyoming in October 1998, had yet to provide concrete evidence of generating increased revenue, or of saving money when compared to royalty in value. In fact, the programs hadn’t even generated the kind of data that would make such comparison possible.

“Since 2001, MMS has been aggressively pursuing an implementation plan to make RIK a permanent part of MMS’ royalty management strategy,” wrote Rebecca W. Watson, the Bush administration’s assistant Interior Secretary for Land and Minerals Management, in a December 2002 response to the Government Accounting Office.

Appointed in November 2001 and confirmed in the first days of the new Bush administration, assistant secretary Watson’s job included overseeing the Bureau of Land Management, the Office of Surface Mining, and the Minerals Management Service that Johnnie Burton would take over in March 2002.

Watson, originally from Chicago, graduated from University of Denver law school in 1978 and began her legal career in Wyoming with a federal judicial clerkship in Cheyenne. She then became a partner in a Sheridan firm, where she represented “ranchers and western businesses.” After a stint as an energy policy lawyer in George H.W. Bush’s Department of Energy, she went to work at the Washington, D.C. international law firm of Crowell & Moringi (1993-95), then became a managing partner at Gough, Shanahan, Johnson & Waterman in Helena, Montana, representing oil, gas, mining and lumber interests. She had strong ties to the ultraconservative, anti-environmental litigation group, Mountain States Legal Foundation, where her boss at Interior, Secretary Gale Norton, had also been a lead lawyer.

Writing in December 2002, Watson defended the controversial Royalty-in-Kind program against Government Accountability Office doubts that Minerals Management had collected the information necessary to evaluate the success or failure of the pilot programs begun four years earlier.

The administration would “continue to build and implement a federal RIK program for [sic] which all Americans can be proud,” Watson said.

Information–reliable data–was a central problem in the planned conversion of the pilots into a permanent, “fully operational” royalty-in-kind program. Without “clear strategic objectives” and good data, Minerals Management 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,” the GAO said.

The amount of oil that MMS took in kind was small from October 1998 through September 2001, but “over the following six months” the amounts ballooned, so that the accountability office estimated that it “may have approached 20 percent of the federal government’s royalty share of all oil produced on federal lands.” The rapid expansion continued until 2007, so that today, in-kind payments make up more than half the royalties oil and gas extracted from federal lands. (The volume of RIK oil and gas has fallen in 2008-09, as Minerals Management removed from the program properties that generated less than fair market value.)

Of the 15.8 million barrels of federal oil sold in pilot sales from October 1998 to July 2002, Minerals Management Service quantified the revenue impacts of only about 9 percent. In Wyoming, of the eight oil sales jointly conducted by the state and feds during this period, Minerals Management evaluated and published the results of only three.

The accountability office said that Minerals Management personnel supplied royalty data from nine Wyoming oil properties that produced about half of the oil sold during the pilot program. The accounting office analysis of the figures revealed “missing, incomplete and inaccurate data, in addition to numerous modifications of data entries by payors [energy companies],” all of which “precluded using these data for accuracy and reasonableness.”

The nine consecutive pilot sales had seen the state and Minerals Management collectively sell federal and state royalty oil, with the federal portion “far exceeding” the state’s. Still, the federal RIK sales from October 1998 to September 2001 was only about 1 percent of all the oil produced on federal lands–yet, Minerals Management could not completely account for the revenues produced.

Since public lands were opened to energy exploitation in 1920, the law has always required the Department of the Interior to obtain fair market value for oil and gas taken in kind. This requirement was underlined in 1953 legislation regulating offshore development, and reiterated in 2001 and 2002 Congressional appropriations for Interior and related agencies, which directed Minerals Management to collect “at least” as much revenue from its RIK pilots as the agency would have gotten in cash royalty payments.

Yet, no one in or out of government knew whether the agency was meeting this standard. The accountability office had doubts, but Minerals Management Service chose not accept the estimation of the Government Accountability Office’s report on its pilot programs. Instead, at a cost of $500,000, MMS hired a consulting company, Lukens Energy Group, to conduct an “independent” assessment of the success of Royalty-in-Kind and to suggest a five-year plan for its expansion.

Lukens Energy was in no way a dispassionate observer of Royalty-in-Kind, but was an active industry advocate. Among its officers negotiating the contract with MMS was Fred D. Hagemeyer, who formerly spent 26 years as a top executive with Marathon Oil. Hagemeyer, as chairman of the American Petroleum Institute’s Royalty Strategy Task Force from 1998 to 2000, testified in favor of Royalty-in-Kind in numerous appearances before Congress, and was an enthusiastic witness for Wyoming Republican Congresswoman Barbara Cubin’s mandatory RIK bill.ii

The petroleum lobby credited him with developing policy that led to “expansion of its [MMS’s] fledgling royalty-in-kind projects.” And in Minerals Management Service’s Lakewood,Colorado royalty-in-kind office, program director Greg Smithiii considered Hagemeyer a “trusted advisor,” according to the Department of Interior’s Inspector General.

Lukens concluded that the RIK pilot had “performed remarkably” and represented a “viable option when compared to royalty-in-value.”

By other accounts, Wyoming’s first experiment with Royalty in Kind–the 1998-2004 state-federal pilot program for oil–was a major disappointment, if not an outright failure, although Minerals Management never conceded anything. In its 2001 evaluation, the agency had declared the program a modest success, claiming that in the review years 1998-2000, the Royalty in Kind program produced $810,000 more in royalties than it would have under the old cash system.

But few people outside the federal agency believed the numbers.

“What did you expect when it was the author of its own report?” said Wyoming Gov. Dave Freudenthal in an interview with WyoFile this spring.

In a separate interview, Mike Geesey, director of the Wyoming Department of Audit who has served governors from both parties, agreed with Freudenthal.

“We’ve consistently had a lot of questions about Royalty in Kind,” said Geesey. “We are very reluctant to believe their numbers.”

A prominent member of U.S. House Government Reform Committee,  New York Democrat Carlolyn B. Maloney, called the report “seriously flawed.”

“Specifically,” said Maloney, “the overall cost benefit analysis of the program does not consider any of the costs associated with running the Royalty in Kind program including processing, transportation, pipeline fees, and other program costs. Given the relative lack of experience that the Minerals Management Service has in these areas, it seems likely that these costs could be considerable.”

Meanwhile, an independent California firm, Innovation & Information Consultants Inc, using the same data reviewed by the Minerals Management Service in its report on the Wyoming RIK pilot, came up with an opposite conclusion.

“RIK sales did not result in the realization of market value,” the consultants told their clients, the city of Long Beach and the state of California, which were considering taking their royalties in kind.

The Wyoming oil pilot program, championed in Washington by Republican Gov. Jim Geringer, State Lands Director Jim Magagna, and newly elected US Rep. Barbara Cubin, sputtered and died in 2006, abandoned by both the state and federal government.

“We just didn’t make much money with it,” said Harold Kemp, assistant director of Wyoming Lands and Investments who ran the program for the state. “Our prices started to go all over the place. The feds and this office abandoned the Royalty in Kind program for oil.”

However, the oil pilot program’s disputed performance did not keep two key Wyoming players in the Royalty-in-Kind movement from pressing the state into what has evolved into a much larger RIK scheme, this time for natural gas.

In 2005, state Treasurer Cynthia Lummis invited her longtime friend Rejane “Johnnie” Burton, director of Minerals Management Service, to meet with the Wyoming Board of Land Commissioners to make a case for using Royalty in Kind for the state’s share of natural gas on federal lands.

According to minutes of the October 6, 2005 meeting, Lummis, now Wyoming’s member of the House of Representatives, moved to adjourn the regular land board meeting and “convene into an executive session to consider proprietary information from an MMS feasibility study.”

No public record of the discussion or documents presented before the land board are available. But in an interview with WyoFile, Gov. Freudenthal said Royalty in Kind “was really pushed hard by the state treasurer [Lummis] and by Johnnie Burton.”

Following the executive session, the board voted to give Johnnie Burton and the Minerals Management Service the green light on the Royalty in Kind scheme for natural gas. The vote was four to one, with Lummis, Secretary of State Joe Meyer, State Auditor Max Maxfield and State Superintendant for Public Instruction Jim McBride all voting yes.

Gov. Freudenthal dissented.

“I had general reservations that the government could ever perform what is in reality a proprietary, private-sector function,” he recalled.

Freudenthal said that he was also worried about corruption in Minerals Management, because of what he learned while conducting a secret federal grand jury investigation when he was US Attorney in Cheyenne from 1994-2001.

“Through the grand jury process,” Freudenthal told WyoFile, “I’d become exposed to things about MMS that I wasn’t comfortable with seeing brought forward as a guiding principle for disposition of what I consider a state resource, which our royalty share is.”

Freudenthal’s reservations proved to be well-founded. According to the August 19, 2008 investigative report produced by Department of Interior Inspector General Earl Devaney, corruption inside the Minerals Management’s Lakewood, Colorado, RIK office was rampant at the very time in 2005 that MMS director Burton and state treasurer Lummis pushed the land board to adopt Royalty in Kind for the state’s royalty share of natural gas.

“We discovered that between 2002 and 2006, nearly one-third of the entire RIK staff socialized with, and received a wide variety of gifts and gratuities from oil and gas companies with whom RIK was conducting official business,” Devaney reported.

Even before the Devaney report was released and raised a furor in Congress, some details of the Royalty in Kind scandal had reached the notice of Secretary of Interior Dirk Kempthorne, who had been appointed to the job by President George W. Bush in May 2006 to replace Gale Norton, a James G. Watt protégée who resigned and took a position with Royal Dutch Shell’s coal bed methane program in Colorado.

Kempthorne decided he needed “outside” advice on the matter, so he turned to one of Minerals Management’s three advisory committees, the Royalty Policy Committee, chaired by senior industry lobbyist David Deal. Deal, a lawyer, is the very definition of a user of the government-industry revolving door, having spent more than 30 years moving between his job at the American Petroleum Institute and various government positions regulating the oil and gas industry.

Johnnie Burton was informed by letter in November 2006 that the subcommittee of the Royalty Policy Committee was to be formed to look into the royalty system. At first she believed that the chair of the new group would come from the existing committee, which was by law composed of 15 members appointed by the Interior Secretary: seven from the oil and gas industry, five from government, and three from “the public.” David Deal, interestingly, represented “the public,” and insiders assumed he would chair the new Subcommittee.

But in March 2007, Kempthorne announced the seven-member advisory Subcommittee on Royalty Management would be co-chaired by two ex-US senators, Jake Garn and Bob Kerry. But no one misunderstood who actually would run the group: subcommittee vice-chairman David Deal, who as undersecretary Stephen Allred observed had “already been instrumental in preparing material” for the subcommittee even before it was officially appointed.

Cynthia Lummis, another active proponent of royalty-in-kind, also accepted appointment to the subcommittee. Its task was “to conduct a full and candid assessment of the department’s mineral revenue management system,” but Deal quickly assured that the subcommittee would not look back on Minerals Management’s former practices, but only forward.

In May 2007, Kempthorne accepted the resignation of Minerals Management director Johnnie Burton, whose five years in office from 2002-2007 included the entire period of reported corruption in the Royalty in Kind office then under her supervision. Kempthorne described Burton, who made $168,000 as MMS director, as a “vital part of the Department of Interior.”

California GOP U.S. Rep. Darrell Issa, ranking member of the House Oversight and Government Reform Subcommittee, was less complimentary.

“This departure,” said Issa, “creates an opportunity to change a culture and history of failed management for the agency that, on behalf of the American people, collects royalties on oil and other resources. Problems at MMS may have cost American taxpayers billions.”

On July 23, 2007, Kempthorne named another Wyomingite, Thayne lawyer and former legislator Randall Luthi, to head Minerals Management.

And on December 17, 2007, Kempthorne’s Subcommittee on Royalty Management issued its 121-page report. The report, released before the Inspector General’s investigation into corruption in the Royalty in Kind operations became public, was generally supportive of RIK as federal policy, particularly for offshore leases. At the end of its work, the subcommittee concluded that although some tinkering needed to be done, MMS’s approach to royalties was basically sound.

“Overall, we concluded that the [Interior] department’s royalty management program is not broken, but needs a major tune-up,” Deal told the House Natural Resources subcommittee.

But among the subcommittee’s recommendations was the following: “MMS should discontinue its onshore RIK crude oil program until it can be determined to be in the best financial interest of the government.”

The Department of Interior halted the onshore crude program.

Significantly, no mention was made of the large-scale natural gas Royalty in Kind program that Cynthia Lummis and Johnnie Burton, who now works for Lummis as a $49,000-a-year aide in the Congresswoman’s Cheyenne office, sold to the Wyoming land commissioners in 2005.

In the past four years the Wyoming natural gas Royalty in Kind program has quietly grown into one of the largest single sources of revenue for the state.  According to Minerals Management officials, in fiscal year 2007-2008 the state received $290-million in RIK royalties, about 53 percent of what the state received for natural gas.

The size of the Wyoming Royalty in Kind program, the only one still operated onshore by the federal government, surprised both Gov. Freudenthal and state Department of Audit director Mike Geesey who told WyoFile that he was under the impression that “the whole program has just kind of shut down.”

The big question now facing  Wyoming, said Freudenthal, is whether the large Royalty in Kind program is returning as much in royalties to the state as would be received under the traditional cash or Royalty in Value program or whether it is actually short-changing the Wyoming people.

In an October 31, 2005, letter to former Minerals Management director Burton the Wyoming land commissioners seemed to recognize the risk the state was taking by dedicating its 50 percent share of royalties on federal lands to Royalty in Kind.

“We understand there is no guarantee that RIK will, in all instances, achieve increased royalties,” the letter, signed by all five board members, stated. “…we recognize that the possibility exists that Wyoming could realize a lower RIK value for its 50% share, relative to the estimated RIV (Royalty in Value or cash) revenues.”

However, the land commissioners said they expected the federal government to keep them updated on the “performance of the pilot RIK program” compared to Royalty in Value.

But four years and more than $500-million later, the promised comparison has not been provided. State audit office director Geesey, who is under contract with Minerals Management to keep tabs on its performance, said in June that no audit had been conducted by the state on the RIK program.

Gov. Freudenthal, who had opposed the Royalty in Kind program from the outset, said in a  June 3 interview that he was in the dark about both its dimensions and its performance. On September 10, he took action, requesting the opportunity to audit the program, so Wyoming can see for itself.

Part IPart IIPart III

End Notes

[i] Best known today as a fierce advocate for private military contractor Blackwater Worldwide

[ii] The Petroleum Institute gave Hagemeyer a special Certificate of Appreciation for his “outstanding service” in 2000. In 2001, he joined the Lukens group as a vice-president.

[iii] Smith was the MMS boss who took illegal drugs and had sex with subordinates “in consort with industry,” according to the Inspector General’s report on the goings-on at Minerals Management’s Colorado RIK office.

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