By Rone Tempest and Laton McCartney

Wyoming Governor Dave Freudenthal says the state should review Wyoming’s participation in a federal minerals royalty program that has come under increasing Congressional scrutiny.

In an interview with WyoFile, the governor said he would ask the director of State Lands and Investments to check into the performance of a federal “Royalty in Kind”program for natural gas launched in the state three years ago.

In one year, the amount of federal natural gas royalties collected under the controversial Royalty in Kind program jumped more than three fold, making it the largest single source of Wyoming's state income.

In 2008, $290 million, or about 53 percent of the state’s share of federal royalties from natural gas on federal land in Wyoming was collected under a“Royalty in Kind” system managed by the federal Department of Interior’s Minerals Management Service.

The Wyoming Board of Land Commissioners voted to join the program in 2005 at the urging of then-State Treasurer and board member Cynthia Lummis and federal Minerals Management director Rejane “Johnnie” Burton, a Wyomingite then in charge of the Washington agency.

The vote was 4-1 in favor with Gov. Freudenthal voting against. The program began in 2006.

“The treasurer [Lummis] wanted it. Johnnie Burton wanted it. And they did it,” Freudenthal recalled.

Freudenthal listed several reasons for his opposition, then and now, to Wyoming’s participation— including evidence of corruption in the Minerals Management Service that had surfaced in a federal grand jury investigation he conducted as U.S. Attorney in Cheyenne from 1994-2001.

Long favored by industry lobbies— including the American Petroleum Institute, the U.S. Oil & Gas Association, the Domestic Petroleum Council, and the Independent Petroleum Association of Mountain States— Royalty in Kind allows producers to pay their federal royalties in oil and gas at the wellhead rather than in cash under the traditional “Royalty-in-Value” system.

Under Royalty in Kind, the government is the marketer, responsible for transporting, processing and selling the oil and gas on the open market.The program grew rapidly under the George W. Bush administration, until it now accounts for more than one-third of the $10 billion to $12 billion the federal government annually collects nationwide in oil and gas royalties.

Lummis, a consistent supporter of the Royalty-in-Kind approach, is now Wyoming’s sole member of the U.S. House of Representatives.

Johnnie Burton, a former Wyoming legislator and state revenue director, resigned her $168,000-a-year job as Minerals Management director in 2007 after a corruption scandal erupted in her department’s Royalty in Kind office and questions were raised about uncollected royalties from federal oil leases in the Gulf of Mexico. Burton now works as a “field representative” in Lummis’ Cheyenne office, where she receives an annual salary of $49,000, according to official State of the Disbursement of the House records.

In written responses to WyoFile questions, Lummis said she still considers Royalty in Kind a viable method for royalty collection.

“In certain scenarios, Royalty in Kind offers a better return to American taxpayers,” Lummis said. “It also avoids controversy over how to value the produced oil and gas when producers remit royalty in kind. In other words, when the U.S. sells its own gas, Americans can be sure they are getting its full market value.”

RIK’s Wyoming Connections – Profiles of Key Players

But Royalty in Kind’s ability to deliver more return to the public than the traditional cash royalty system is much disputed.

Minerals Management Service issues regular reports to Congress stating that Royalty in Kind outperforms the Royalty in Value, or cash, system.

However, Mike Geesey, director of the state of Wyoming Department of Audit in charge of keeping tabs on royalties, said in an interview with WyoFile that he is not convinced by the Minerals Management case for Royalty in Kind.

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

Reports by both the federal General Accounting Office and the Office of the Inspector General have also raised questions about Mineral Management’s bookkeeping procedures and accuracy.

The Minerals Management Service, GAO auditor Frank Rusco told Congress on March 11, 2008, “lacks adequate performance measures for its Royalty-in-Kind program… The MMS methodology for comparing the value of Royalty-in-Kind oil and gas with what it would have received had the royalties been paid in cash is subject to a lot of unreported uncertainty.”

Wyoming was the site of the nation’s first oil Royalty in Kind pilot project, starting in 1998. The pilot project had been actively sought for the state by Wyoming’s Republican officials, including Governor Jim Geringer, Wyoming Department of Revenue Director Johnnie Burton, and Cynthia Lummis, who in 1997-98 served as interim director of Wyoming Lands and Investments.

Reporting in 2001 on the results of the Wyoming pilot, Minerals Management Service claimed that it outgained the old cash system by $810,000 for a two-year period, 1998-2000.

But when an independent California firm, Innovation & Information Consultants Inc., examined the same 1998-2000 data at the request of the city of Long Beach and the State of California, which were then looking into adopting Royalty in Kind, its experts concluded that the “RIK sales did not result in the realization of market value.”

More troubling, the firm concluded that the Royalty-in-Kind system was more susceptible to “gaming” by oil and gas producers than the traditional cash system.Under Royalty in Kind, both the California firm and GAO reports concluded, the government relied even more heavily on self-reporting by the industry than under the cash royalty system.

“Indeed,” the Innovation & Information authors reported, “the ability to monitor and audit RIK sales is more limited than under an in-value royalty program….”

A member of the House Government Reform Committee, New York Democrat Carolyn B. Maloney, also strongly disputed Minerals Management’s positive evaluation of the Wyoming pilot project.

“The report’s conclusions that Royalty in Kind generated approximately $810,000 more revenue than royalty in value appear seriously flawed,” Maloney wrote. “Specifically, 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.”

After the eight-year federal-state experiment with Royalty in Kind for Wyoming oil, the state dropped the project in 2006 because of high volatility in oil markets and uncertain results.

“We just didn’t make much money,” said Harold Kemp, assistant director of Wyoming Lands and Investments in charge of the mineral leasing and compliance program. “Oil prices started to go all over the place. The feds and this office abandoned the Royalty-in-Kind program for oil.”

However, the government partners in 2005 took on a much larger Royalty-in-Kind program for natural gas produced on federal lands in Wyoming. This is not a pilot. Approved by Lummis and the other state elected officials over Freudenthal’s opposition in 2005, it is the largest such onshore program the Department of the Interior operates.

Under federal law, 49 percent of the royalties collected by the federal government are returned to the state of Wyoming.

What is not clear to him, said Freudenthal, is if the money that Wyoming gets via Royalty in Kind is more than the state would received in a cash-royalty system. In other words, are Wyoming citizens being short-changed?

“Basically, as I sit here today, I don’t know,” Freudenthal said. “Maybe we better go look at this.” Freudenthal said he would talk with state lands Director Lynne Boomgaarden about reviewing the program.

Ultimately, any decision to remove Wyoming’s share from the federal program would require another vote by the Wyoming Land Commission.The Land Commission is made up of the state’s five statewide elected officials: governor, auditor, treasurer and superintendent of public instruction.

A Wyoming decision to pull out of the Royalty in Kind program would likely face strong opposition from the oil and gas industry, for whom the implementation of Royalty In Kind climaxed years of lobbying both in Wyoming and in Washington, D.C.

Industry representatives say they favor the Royalty-in-Kind system’s “simplicity” and what they contend is a reduction in lawsuits and other disputes over cash royalty payments.

In Wyoming and other states starting in the mid-1980s, for example, county governments and private landholders hired independent auditors to check the accuracy of oil and gas company production reports, used as the basis for royalty cash payments. In Wyoming alone, 18 of 23 counties hired private mineral auditors who collected hundreds of millions of dollars in unpaid royalties, penalties and interest.

The advantage of Royalty in Kind, said former New Mexico US Rep. Steve Pearce, a Hobbs, N.M., oilman, during the March 11, 2008 hearing of the House Energy and Mineral Resources subcommittee, is that “you just read the meter” and give the government its share in oil or natural gas.

“You don’t have to do the complex calculations with lawyers and auditors in the way that we are processing right now,” said Pearce, then the ranking Republican on the subcommittee. “The non-Royalty-in-Kind process attracts lawyers and auditors like sharks to blood.”

But Royalty in Kind has come under fire on several fronts following a series of 2008 reports by the Department of Interior Inspector General’s office that showed a pattern of corruption and improper behavior among Minerals Management bureaucrats and their industry counterparts.

In his September 9 report, Inspector General Earl E. Devaney said his two-year, $5.3 million investigation found a “culture of ethical failure” in the Royalty-in-Kind program, in which federal bureaucrats caroused with industry representatives, accepted tens of thousands of dollars in gifts and favors, and violated numerous standards for open and fair bidding on contracts.

Critics of the system, including Gov. Freudenthal, contend that state and federal governments are not equipped to operate as quasi-private enterprises, attempting to market natural gas, especially in the rough-and-tumble energy commodities markets. Government operating this way, Freudenthal said, breeds unhealthy favoritism and untoward personal relationships.

“Remember, you are asking the government to perform a private-sector function, but it has none of the private-sector discipline that comes from profit and loss,” Freudenthal said.“That allows it to become more relational and less business. It’s like that old rule about ‘Good fences make good neighbors’— and the fences were gone. And I think you need them.”

Howard Schrinar, a former Wyoming director of Lands and Investments, told WyoFile he was always leery of the government’s capacity to manage Royalty-in-Kind programs.

“If you are going to get into the gas and oil marketing business,” said Schrinar, who is now an executive with Peabody Energy in Gillette, “you better have some pretty sharp people. And you aren’t going to get them on state or [U.S.] government salaries.”

Stephen Reynolds, a Cheyenne energy consultant who succeeded Lummis as director of Lands and Investments in March 1998, started out as a proponent of Royalty In Kind. He headed the office when the first pilot program was launched in the state.

Since then, however, Reynolds said he began to have some doubts about the federal government’s ability to administer the program.

“Governments make poor capitalists,” Reynolds told WyoFile.

In September 2008, Wyoming U.S. Senator John Barrasso, a Republican, and Oregon U.S. Senator Ron Wyden, a Democrat, co-authored a bill that called for suspension of the federal Royalty-in-Kind program unless major reforms were instituted inside Minerals Management Service within 60 days.

“The recent investigation,” said Barrasso, “raises serious questions of public trust and illustrates a total disregard for personal, professional and programmatic ethics.”

Wyden was even more condemning.

“The federal organization charged with collecting billions of dollars of royalties from oil and gas leases on public lands cannot be allowed to carry on like some corrupt, Third World bureaucracy from a bad Hollywood movie,” he said.

The Wyden-Barrasso bill, which called for Senate confirmation of any future Minerals Management director, was referred to their own committee and died there.

But this past January, new Secretary of Interior Ken Salazar pledged to reopen the investigation into alleged Minerals Management Service and Royalty-in-Kind malfeasance.

“There’s a new sheriff in town,” Salazar announced in a January 28, 2009 visit to the Royalty-in-Kind office in Lakeland, Colorado.

And several additional bills, broader in scope than the Wyden-Barrasso legislation, are now circulating in Congress aimed at cleaning up the federal royalty collection system. According to Congressional sources, a new report being prepared for the House Oversight Committee is also expected to widely condemn the program.

One draft bill (pdf) prepared by the House Resources committee under its chairman, West Virginia Democrat Nick Rahall, calls for an end to the Royalty-in-Kind program as part of an overall restructuring of the Department of Interior.

Section 514 of the draft bill, entitled “Limitation on Royalty In-Kind Program,” amends the federal Mineral Leasing Act (30 U.S.C. 192) to read that the Interior Secretary “shall not conduct a regular program to take oil and gas lease royalties in oil or gas.”

Additional Resources

WyoFile Interview with U.S. Rep. Cynthia Lummis on Royalty in Kind

WyoFile Interview with Governor Dave Freudenthal on Royalty in Kind

Draft Bill for Federal Lands and Resources Energy Development Act of 2009 (pdf)

RIK’s Wyoming Connections – Profiles of Key Players

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  1. It’s interesting to learn about the royalty-in-kind program where producers pay their royalties in either gas or oil at the wellhead instead of paying in cash. My father is thinking of selling mineral rights to his plot of land and is also considering the buyer’s ability to satisfy federal royalties and avoid problems. This is something I can share to him so he can check that all royalties are being accounted for when he goes ahead with the deal.