Feds Gone Wild, Part II

Part IPart IIPart III

How Royalty in Kind went from Wyoming to the national stage. A True story.

By Laton McCartney and Rone Tempest

When President Bill Clinton signed the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996 into law in Jackson Hole, his Washington, D.C.-based Minerals Management Service director, Cynthia Quarterman, came out to attend the August ceremony.

Her summer had been busy and, one might assume, stressful. She had appeared several times before different Congressional committees investigating her agency’s work collecting oil and gas royalties. At one vituperative hearing in mid-June, she had been grilled by a New York Democratic Congresswoman, Carolyn B. Maloney, who clearly did not believe Minerals Management Service was doing its job.  At the hearing, Quarterman had been confronted by Maloney’s own hostile report, issued jointly with the private nonprofit Project on Government Oversight, that accused Minerals Management in its entirety, “including its politically appointed leadership over several administrations,” of “bad faith,” and said the Interior Department had such a “dismal record of negligence, misfeasance, and incompetence” that there was no hope Minerals Management could improve.

“The Department of the Interior is institutionally unwilling to aggressively collect the money owed to the American people by the oil industry,” stated Maloney’s report, titled A Wink and A Nod: How the Oil Industry and the Department of Interior are Cheating the American Public and California Schoolchildren. The report said that “for decades” Interior had given “loyal and devoted service to the petroleum industry” and had a record “replete with mismanagement, duplicity, evasions, and outright lies.”

When the subcommittee chairman, Los Angeles Republican Stephen Horn, asked Quarterman if she wished to respond to POGO and Maloney’s report, she said “I do like the title” and added that their “heart is in the right place.”

So maybe it was nice for Quarterman to visit Wyoming at the summer’s end and, in the grand wilderness setting, issue her own congratulatory press release on the signing of the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996.

In the release, Quarterman applauded the passage of the new law and offered her personal thanks to its architects.  She observed that the act fulfilled the president’s one-year-old “pledge to the natural gas and oil industry” to “improve and streamline” the federal royalty program. She listed a few of the good things the act brought to industry—a seven-year statute of limitations on royalty collections; interest payments by government to industry on overpayments; refunds to companies for the same—and went on to note that Minerals Management Service had itself “embarked upon a series of continuous- improvement initiatives” in the spirit of the new law.  One of the fresh launches she listed was “piloting an offshore royalty in-kind program.”

Quarterman did not mention improvements in Minerals Management’s valuation system, because those were still pending. But she had noted earlier in the summer that “valuation, determination, and collection procedures have been subject to debate and litigation for years” and that the offshore gas Royalty-in-Kind pilot was an effort to “streamline these processes without sacrificing royalty revenues.” The current valuation problem was that Minerals Management Service’s proposed new rules  tied royalty payments directly to the market, so that as oil prices rose, so would royalties. The oil and gas industry did not want to pay more royalties. Implementation of the new rules had so far been successfully delayed in Congress by the attachment to appropriations bills of  little-noticed riders barring implementation. While the rules pended, the industry geared up to have in-kind royalties substituted for cash payouts.

Quarterman had been named director of Minerals Management in March 1995i, when the royalty-in-kind pilot program was already three months old.  The idea was not new, and the practice was already suspect in some quarters, although Republicans championed it as an easy way out of the valuation problem. .

In June 1996, the House Committee on Government Reform and Oversight had heard testimony on undervaluation of crude oil taken from federal leases.  Quarterman had testified.  Royalty-in-kind crude oil transactions, the committee’s report observed, “may have left U.S. financial interests unprotected.”  The committee cited a May 1996 inter-agency task force report that had pointed out:

In concept, royalty-in-kind oil is taken by the Department of the Interior and sold directly to a refiner. In practice, the Department relied on the Federal leaseholder [the royalty-paying company] and the refiner-purchaser to arrange the terms of sale and transfer to the refiner’s facility. The Federal Government then received payment from the refiner. Typically, this was the posted price, which has been determined to be undervalued. … [T]he Federal Government may not have received all of the fair market value of the crude oil which it was due since some of the value may have been retained by the leaseholder through excessive transportation charges.

Yet, Republican legislators liked royalty-in-kind and supported it at this hearing.  One who testified was the House sponsor of the new Federal Oil and Gas Royalty Simplification and Fairness Act, Republican Ken Calvertii of California, chairman of the House Subcommittee on Energy and Mineral Resources. He was a strong early supporter of taking royalties in kind, as was his fellow Republican committee member, Barbara Cubin of Wyoming.

“When we get to the point of valuation, that is going to be a continuing problem,” Calvert told the House Reform and Oversight committee. “And I think royalty in kind is an interesting way of taking care of that problem. In effect, the Government would be selling its share of product at the marketplace and that forevermore will take care of that problem.”

Quarterman in 1996 described the pilot program, which involved offshore gas, as a “dramatic effort by MMS to do business in a different manner” since 1992 deregulation had created a new, highly complex market. In the Royalty-in-Kind gas pilot, she wrote, Minerals Management, “is testing the concept of removing itself from the complex practice of determining the appropriate value of production and auditing whether companies have paid royalties based on an appropriate value.”

Having the government “remove itself” from the complex tasks of valuation and auditing was exactly what attracted Republicans to the idea of taking royalties in kind. Democrats were not quite as generally enthusiastic, but had lost control of Congress and were, with the Clinton administration, busily “reinventing government.”  Almost everyone was talking about “streamlining” and “reducing administrative burdens” and “simplifying” procedures for energy producers.  Almost no one—except perhaps the obstreperous New York Rep. Carolyn B. Maloney—was talking about protecting America’s revenues.

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