Cubin Examines Using RIK for LIHEAP

Representatives of the oil and gas industry last week applauded the Bush administration's effort to use gas royalties, in-kind or in-value, to bolster the Low Income Home Energy Assistance Program (LIHEAP). The House Resources Subcommittee on Energy and Mineral Resources held an oversight hearing last Tuesday to examine the possibility of expanding the Minerals Management Service's existing royalty in-kind (RIK) pilot programs in Wyoming (oil) and the Gulf of Mexico (oil and natural gas) to meet the administration's request.

The MMS' RIK pilots have been part of a series of tests to determine the best method for collecting royalties from producers. The oil and gas industry has strongly favored paying royalties in kind rather than in value because of the lengthy disputes over calculating value at the wellhead for the purpose of separating out the royalties owed to the government. However, the Clinton administration opposed expanding the existing RIK program because of concerns over maintaining steady revenue collections. With positive results coming out of the existing RIK pilots, the new administration apparently favors an expansion and increasing the uses of the government's royalty share of production.

"The RIK idea has engendered passionate debate in the past about whether the oil and gas industry is trying to escape its proper obligation to pay a royalty based upon a fair market value of the production," noted Subcommittee Chair Barbara Cubin (R-WY). "I believe that demagoging the industry as `cheats' is unproductive. Yes, large sums have been proffered by companies in settlements of lawsuits and a recent judgement in an Alabama court levied a huge award against one major oil company. But a jury in California a few years ago rebuffed claims that this same company had cheated on its state lease obligations.

"One point should be obvious--had the federal lessees paid these disputed royalties in-kind, the U.S. taxpayer would have been the immediate beneficiary because there would have been no delay in collecting the proper value," she said. With that in mind, Cubin set out to determine the best method of using royalty gas in kind for the purpose of serving "our less fortunate citizens on a cold winter's night or a hot summer's day."

Poe Leggette, a lawyer representing the American Petroleum Institute, the Independent Petroleum Association of America, the Independent Petroleum Association of Mountain States, the Domestic Petroleum Council and the U.S. Oil and Gas Association, said the industry believes RIK is the way to go if the president wants to use royalties to help LIHEAP. "While problems inevitably have arisen [with the RIK pilots], the industry views none of these as being intractable" as long as the MMS continues searching for the most efficient solutions, Leggette said. RIK is a far better solution than endlessly arguing over the value of production for the purpose of calculating royalties at the wellhead, he noted.

"Capturing volume is a very simply process by comparison... A cubic foot of gas is a cubic foot of gas. So long as the measuring devices used are accurately calibrated, there is no room for interpretation and no need to estimate the value of production."

Producers urge the government to make RIK the standard method of collecting royalties, he said. "A permanent RIK program would greatly enhance government flexibility by offering several options for disposing of its royalty share: selling the royalty production on the open market or to small refiners; making available the royalty production for use in government/public facilities; filling the Strategic Petroleum Reserve; or providing cheaper energy to pre-approved low-income families." He said the RIK pilots have proven that taking royalties in kind can increase government revenues while decreasing administrative costs.

However, barriers to expansion of the RIK pilots exist, said Leggette. New legislation should clearly delineate producer and government obligations and give the government more flexibility in how it can use the royalty production and revenues, he added.

Walter Cruickshank, associate director of policy and management improvement at the MMS, drew only a few conclusions about the MMS' four existing RIK pilots. However, he noted that the Wyoming RIK (6,000 b/d of crude since 1998) successfully demonstrated "that in some but not all circumstances, taking oil production in kind and selling it through a competitive bid process is a viable alternative to the historical method of taking royalties in value." He noted that MMS received an average premium of 45 cents/bbl over the values reported to the state of Wyoming for royalty and severance tax purposes. The 8(g) Offshore Texas and Gulf of Mexico gas pilots currently include 380,000 MMBtu/d of gas out of the government's total 2.5 Bcf/d offshore royalty share. And the MMS expects to begin taking 7,600 b/d of Gulf oil in kind in September.

"By any standard, the royalty revenues received in 2001 by the government can be considered a windfall for the federal treasury and for the onshore states that receive a 50% share of these onshore royalty revenues," John A. Harpole, president of Denver-based energy services consulting firm Mercator Energy, told the subcommittee. "Rather than see that windfall `disappear' into federal and state treasuries, why not incorporate those dollars in a solution for the needy?"

Harpole noted that in January 2000, New York utility KeySpan Corp.'s 54,000 pre-qualified low-income customers accounted for 8,200 MMBtu/d of gas demand, which is less than 0.3% of the federal government's total offshore royalty gas volume. That gas is shipped to New York under existing long-term contracts with Gulf producers. One option for the LIHEAP transfer could allow the producers to set aside a portion of the gas they deliver as LIHEAP gas with a pre-specified "trigger price" set by the Department of the Interior. The amount could be specified on existing royalty paperwork submitted by the producer. Such an option would produce little additional administrative burden, said Harpole. Other options also could be used, but the bottom line is that LIHEAP customers should benefit from in-kind gas deliveries at a time when gas prices are so high, he said.

Enabling legislation, however, is required to address the Mineral Leasing Act and the Outer Continental Shelf Lands Act to allow the secretary of the Interior to accept a price that benefits the low-income customers, Harpole added.

"More than enough federal royalty gas exists to satisfy all of the low-income demand nationwide. The nation's top 25 natural gas utilities serve 52.5% of all residential consumers in the United States. Under the above described `KeySpan' approach, one deal alone can cover the low income needs behind one of the largest gas utilities in the country utilizing only 3/10ths of one percent of the available offshore federal royalty gas volumes. Imagine what 25 deals a month could do for other low-income and fixed income customers! Auditing 25 transactions a month would be a nominal task for the MMS given the measure of benefit it would provide to recipients."

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