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CAN THE UNITED STATES INCREASE OIL ROYALTIES? Y 4. G 74/7; 01 5/6 Can the United States Increase Dil... HEARING BEFORE THE SUBCOMMITTEE ON GOVERNMENT MANAGEMENT, INFORMATION, AND TECHNOLOGY OF THE COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT HOUSE OP REPRESENTATIVES ONE HUNDRED FOURTH CONGRESS SECOND SESSION JUNE 17, 1996 Printed for the use of the Committee on Government Reform and Oversight U.S. GOVERNMENT PRINTING OFFICE 43-977 WASHINGTON : 1997 ForsalebytheU.S.GovernmentPrintingOffice SuperintendentofDocuments,CongressionalSalesOffice,Washington,DC 20402 ISBN 0-16-055698-8 CAN THE UNITED STATES INCREASE OIL ROYALTIES? Y 4, G 74/7; 01 5/6 Can tlie United States Increase Oil... HEARING BEFORE THE SUBCOMMITTEE OX GOVERNMENT MANAGEMENT, AND TECHNOLOGY INFORiA'IATION, OF THE COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT HOUSE OP REPRESENTATIVES ONE HUNDRED FOURTH CONGRESS SECOND SESSION JUNE 17, 1996 Printed for the use of the Committee on Government Reform and Oversight feB 09 fr,r.. 'Ml ^'/#JU^ U.S. GOVERNMENT PRINTING OFFICE 43-977 WASHINGTON 1997 : ForsalebytheU.S.GovernmentPrintingOffice SuperintendentofDocuments,CongressionalSalesOffice,Washington,DC 20402 ISBN 0-16-055698-8 COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT WILLIAM F. CLINGER, Jr., Pennsylvania, Chairman BENJAMIN A, OILMAN, New York CARDISS COLLINS, IlUnois DAN BURTON, Indiana HENRY A. WAXMAN, CaUfomia J. DENNIS HASTERT, Illinois TOM LANTOS, California CONSTANCE A. MORELLA, Maryland ROBERT E. WISE, Jr., West Virginia CHRISTOPHER SHAYS, Connecticut MAJOR R. OWENS, New York STEVEN SCHIFF. New Mexico EDOLPHUS TOWNS, New York ILEANA ROS-LEHTINEN, Florida JOHN M. SPRATT, Jr., South Carolina WILLIAM H. ZELIFF, Jr., New Hampshire LOUISE McINTOSH SLAUGHTER, New JOHN M. McHUGH, New York York STEPHEN HORN, CaUfomia PAUL E. KANJORSKI, Pennsylvania JOHN L. MICA, Florida GARY A. CONDIT, California PETER BLUTE, Massachusetts COLLIN C. PETERSON, Minnesota THOMAS M. DAVIS, Virginia KAREN L. THURMAN, Florida DAVID M. Mcintosh, Indiana CAROLYN B. MALONEY, New York JON D. FOX, Pennsylvania THOMAS M. BARRETT, Wisconsin RANDY TATE, Washington BARBARA-ROSE COLLINS, Michigan DICK CHRYSLER, Michigan ELEANOR HOLMES NORTON, District of GIL GUTKNECHT. Minnesota Columbia MARK E. SOUDER, Indiana JAMES P. MORAN, Virginia WILLIAM J. MARTINI, New Jersey GENE GREEN, Texas JOE SCARBOROUGH. Florida CARRIE P. MEEK, Florida JOHN B. SHADEGG, Arizona CHAKA FATTAH, Pennsylvania MICHAEL PATRICK FLANAGAN, Illinois BILL BREWSTER, Oklahoma CHARLES F. BASS, New Hampshire TIM HOLDEN, Pennsylvania STEVEN C. LaTOURETTE, Ohio ELIJAH CUMMINGS, Maryland MARSHALL "MARK" SANFORD, South Carolina BERNARD SANDERS, Vermont ROBERT L. EHRLICH, Jr., Maryland (Independent) James L. Clarke, StaffDirector Kevin Sabo, General Counsel Judith McCoy, ChiefClerk Bud Myers, Minority StaffDirector Subcommittee on Government Management, Information, and Technology STEPHEN HORN, California, Chairman MICHAEL PATRICK FLANAGAN, Illinois CAROLYN B. MALONEY, New York PETER BLUTE, Massachusetts MAJOR R. OWENS, New York THOMAS M. DAVIS, Virginia JOHN M. SPRATT, Jr., South CaroUna JON D. FOX, Pennsylvania PAUL E. KANJORSKI, Pennsylvania RANDY TATE, Washington COLLIN C. PETERSON, Minnesota JOE SCARBOROUGH, Florida TIM HOLDEN, Pennsylvania CHARLES F. BASS, New Hampshire Ex Officio WILLIAM F. CLINGER, Jr., Pennsylvania CARDISS COLLINS, lUinois J. Russell George, StaffDirector and Counsel Mark Brasher, Professional StaffMember Ian Davison, StaffAssistant Mark Stephenson, Minority Professional StaffMember David McMillen, Minority Professional StaffMember (II) CONTENTS Page Hearing held onJune 17, 1996 1 Statement of: Armstrong, Robert L., Assistant Secretary ofthe Interior, Land and Min- erals Management, U.S. Departmentofthe Interior 56 Calvert, Ken, a Representative in Congress from the State ofCalifornia ... 10 McMahon, M. Brian, attorney for the city of Long Beach, trustee for the State of California, accompanied by Robert Shannon, assistant city attorney, city of Long Beach; and James McCabe, deputy city attorney, city ofLong Beach 68 Quarterman, Cjnithia, Director, Minerals Management Service, Depart- ment ofthe Interior, accompanied by Robert Berman, economist. Office of Policy Analysis, Department of the Interior; Abraham E. Haspel, Acting Principal Deputy Assistant Secretary for Policy and Inter- national Affairs, Office ofPolicy and International Affairs, Department of Energy, accompanied by Robert Speir, economist. Office of Oil and Natural Gas Policy, Department ofEnergy 21 Letters, statements, etc., submitted forthe record by: Calvert, Ken, a Representative in Congress from the State ofCalifornia: Letterdated May 30, 1996 11 Prepared statement of 14 Maloney, Hon. Carol3Ti B., a Representative in Congress from the State ofNewYork: Letterdated March 29, 1994 67 Testimony ofthe Projecton Government Oversight 6 McMahon, M. Brian, attorney for the city of Long Beach, trustee for the State ofCalifornia, prepared statement of 75 Quarterman, C3mthia, Director, Minerals Management Service, Depart- ment ofthe Interior, prepared statementof 24 (III) CAN THE UNITED STATES INCREASE OIL ROYALTIES? MONDAY, JUNE 17, 1996 House of Representatives, Subcommittee on Government Management, Information, and Technology, Committee on Government Reform and Oversight, Washington, DC. The subcommittee met, pursuant to notice, at 9:30 a.m., in room 2154, Raybum House Office Building, Hon. Stephen Horn (chairman ofthe subcommittee) presiding. Present: Representatives Horn and Maloney. Staff present: J. Russell George, staff director and counsel; Mark Brasher, professional staff member; Ian Davison, staff assistant; and Mark Stephenson and David McMillen, minority professional staffmembers. Mr. Horn. Good morning. A quorum being present, the Sub- committee on Government Management, Information, and Tech- nology will come to order. On April 25, 1996, the Debt Collection Improvement Act passed the House of Representatives and was subsequently enacted into law. The purpose of that measure, which I introduced and was joined by the ranking minority member, Mrs. Maloney of New York, was to provide the Federal Government with the tools that it needs to collect the money that is due it. The Nation's enormous deficits demand that the Federal Government take every step to collect outstanding amounts. In today's hearing, the subcommittee asks: one, has the valuation ofthe oil produced on Federal leases been fair and reasonable, and, two, are the Federal Government and other entities which might be involved receiving the royalties owed in a timely manner? On May 16, the Department of the Interior released an interagency report which examined the valuation of California oil produced on Federal lands, and the oil royalty payments which re- sulted from that production. The report entitled, "Final Interagency Report on the Valuation of Oil Produced from Federal Leases in California," concluded that during the years 1978 through 1993, there was a possible undervaluation of California oil. Query, given the lower grade of oil produced in California compared to Alaska and Texas, is that necessarily so? Those responsible for the administration of Federal oil properties believe that the posted price of oil was understated, and, if so, the Federal royalty received could also be understated. We will be interested to learn how that valuation system works. (1) The conclusion reached by the Department of the Interior seems supported by a comment attributed to a representative of an oil company which called the posted price a "dinosaur" which bears no relationship to the market value of the oil. The Federal Govern- ment must ensure that it has a reliable gauge by which to measure the value of oil so that the Government collects all the revenue to which it is appropriately entitled. This is potentially an enormous problem. The report concluded that the underpayment ranges from zero dollars to possibly $856 million, for California alone. The report does not consider the other 49 States. It does not cover the natural gas leases. In California, the State portions of the royalty are dedicated to funding kinder- garten through 12th grade education. With that most important use of the pajrment at stake, it is clear that we might well need better management ofthe Federal oil and gas leasing program. This issue continues to be the subject of litigation by the States because of vague Federal rules and apparent lack of resources to pursue the matter. Congress needs to work with the administration to identify better ways to manage the leasing programs. One option is turning the administration of these programs over to those States which already seem eager to audit the oil leasing program. My colleague from California, Representative Ken Cal- vert, has introduced legislation to accomplish this approach. His bill, H.R. 1975, however, does not provide for retroactivity. Although his legislation was vetoed by the President when it was included as a part ofthe budget reconciliation measure, the administration has expressed support for the bill. If enacted, the Calvert approach will solve the undervaluation problem in the future, but leave any undervaluation during the 1978 through 1993 period un- resolved. This morning we hope to learn if the Department of the Interior needs to make improved management and collection of royalties a priority. Does the ranking minority have an opening statement? Mrs. Maloney. Yes, I do, Mr. Chairman, and thank you very much for holding this hearing so swiftly after my office and POGO released a report requesting a hearing and the other task report came out. First of all, I deeply want to express my appreciation for holding this hearing on Federal royalty undervaluation. This might sound like an old problem but it is a problem that has not yet been solved, and I want to commend you and your stafffor bringing this issue before the committee. I might add, that your great State ofCalifornia has a deep inter- est in solving this problem, as half of the money due back on Cali- fornia onshore production would mean at least $142 million for the State ofCalifornia. I also want to congratulate the administration's efforts on this issue. The Department of the Interior set up an interagency task force which focused on California crude oil valuation. Their report states clearly that 10 oil companies owe the Federal Government up to $856 million in oil royalty and underpayments in California alone. This report is strong and to the point. I think our job now is to immediately begin collecting this money for the American people. The task force report brings up many very important issues from which we must take action. Most important, we must decide how to collect and from what period to collect underpaid royalties. The task force discusses two methodologies on how to collect: No. 1, using Alaskan North Slope spot prices referred to as ANS prices and, No. 2, computing premiums paid on arm's length contracts. The first method would bring in $856 million, and the second method would likely bring in less than half that. I recommend using the Alaskan North Slope price because it is simpler, more ac- curate, it is the method the oil companies use themselves, and it will bring in at least twice as much money. Between 35 and 45 percent of oil refined in California comes from the Alaskan North Slope. That represents a significant quantity. Likewise, less than 20 percent of oil is traded at arm's length, which is not a significant quantity. Yet, Federal regulations require significant quantity when computing arm's length contract pre- mium. According to the task force report, which is based on the court- sealed documents from the Long Beach cases 1 and 2, the oil companies use the Alaskan North Slope spot prices to base the value of their oil. If it is good enough for the oil companies, it should be good enough for the State of California and the Federal Govern- ment. Calculating underpaid royalties by using the Alaskan North Slope spot prices is very easy because the value ofANS oil is pub- lished widely in trade journals; however, trying to calculate premiums paid on arm's length contracts would take not only years to accomplish but would most likely be very inaccurate. The task force report even admits to some ofthese pitfalls. For example, on page 18 the task force reports. Most oil from Federal oil and gas leases is produced by integrated companies that transfer production from their production arm to a trading or refining arm. After this initial nonarm's length transfer, oil produced from Federal leases loses its iden- tity in companies' accounting systems so that its price subsequent to transfers usu- allycannotbe determined. Then page 34, it goes on to say: "Rarely is it possible to trace Federal production past the first transfer between the company's production and trading affiliates." On pages 49 and 50, the report says, After transferring Federal crude ofa specific type to a company^s trading division, the distinction between Federal and non-Federal crude oil was lost. Federal crude oil was not specifically invoiced in companies' records after internal transfers, so it is unlikely that gross proceeds in excess ofposted prices canbe traced to the produc- tionofspecific Federal leases. It is my opinion that the oil companies could easily bury the already understaffed royalty management program audit teams in a maze of company trading transactions. That is not to mention the legal roadblocks and endless appeals the oil companies will use to prevent the release of their affiliate's records. ANS is by far the easiest and most logical method to use. The second important question is which time period do we use to limit our collection of undervalued royalties? Over the last few months I have uncovered evidence that posted prices have not rep- resented market value since the 1930's. According to the task force report, two task force team members recommended going back to at least 1980. The other team members make no recommendation. I recommend at the very least that we should commit to using 1980 as the reasonable starting point. Clearly, 74 percent of the undervalued crude oil was sold from 1980 to 1985. Collecting on these 6 years alone would bring the Federal Government over $500 million. Contributing to the undervaluation problem is that some pipelines are not operating as common carrier pipelines. However, Federal law requires that pipelines which cross Federal land operate as common carriers. Oil companies which use noncommon carrier pipelines exercise tremendous market power over all other oil companies. As long as pipelines are not opened up as common carriers, the California oil market will never be a free market with open competition. As such, I recommend that the Secretary of the Interior use his powers to immediately enforce common carrier access to all California pipelines which cross Federal land. We have waited long enough. On behalf of the American people, the Federal Government should start collecting royalties based on the market value for oil. The evidence to date shows that we have not been getting our money's worth. We need to fix this problem now and collect all that is owed us from the past. As such, I urge the Department of the Interior to take immediate steps to collect the money owed. We should also change the regulations so that they are more helpful in the future. Over the last few months very compelling evidence has come to my attention that oil in Texas, New Mexico, Louisiana, Wyoming, and a dozen other States has been undervalued. This is not sur- prising because oil trading in California is very similar to oil trading in the Gulf States. As such, I have made a request to Assistant Secretary Robert Armstrong that the task force continue their in- vestigation to include oil and gas undervaluation beyond the State of California. A future task force would most likely discover that the $856 million figure for California would probably increase to several billion dollars once offshore and onshore production from the rest ofthe country is included. Finally, I strongly believe that all future global settlements should specifically exclude the oil and gas undervaluation issue throughout the country. The Department of the Interior already made the mistake of globally settling with Exxon only to find out later that Exxon owed nearly $200 million in underpaid royalties. With the release of the task force report, we now have convincing evidence that the oil and gas undervaluation issue exists. We would make a huge mistake if we globally settled with additional oil companies and gas companies. I would like to put into the record, Mr. Chairman, a letter that I wrote to Mr. Armstrong, the Assistant Secretary of Land and Minerals Management, calling upon him not to have any more global settlements until this issue is resolved. I would likewise like to put into the record the testimony of the Project on Government Oversight. They weie not able to testify