The Minerals Management Service's (MMS) most-recent estimate that between $6.4 billion and $9.8 billion in royalties could be lost to the federal government as a result of missing price thresholds in 1998 and 1999 deepwater oil and natural gas leases is "reasonable," the Government Accountability Office (GAO) said in a report released Friday.

"We believe the methodology and assumptions used by MMS to make these estimates are reasonable. However, because there is considerable uncertainty about future oil and natural gas prices and production levels, actual foregone royalties could end up being higher or lower than MMS' estimates," said the agency, an investigative arm of Congress. The MMS has calculated that the missing price thresholds in the 1998-1999 leases already have cost the federal government $1 billion in lost royalty revenues.

Following congressional passage of the Deep Water Royalty Relief Act (DWRRA), the MMS gave producers a break on royalties in the late 1990s, when oil and gas prices were low, to spur exploration and production in the Gulf of Mexico. The lease agreements were supposed to contain price-threshold language stating that the price relief would come to an end when oil and gas market prices soared above a certain level. But the Interior agency left this language out of the 1998 and 1999 leases -- a mistake that is allowing producers to escape royalties on certain volumes despite the high prices for oil and natural gas. The MMS has been under intense pressure from Congress to renegotiate the leases to recover the royalties.

Sen. Jeff Bingaman (D-NM), chairman of the Senate Energy and Natural Resources Committee, and a number of other senators and House lawmakers requested the GAO report.

The GAO disagreed with MMS' estimate that potential foregone royalties on future production could be up to $60 billion over the life of the leases if the federal government loses a lawsuit brought by Kerr-McGee Corp. Kerr-McGee has challenged the Interior Department's authority to place thresholds on all leases that were issued under the DWRRA. The lawsuit in particular seeks to remove the price thresholds on leases that were issued in 1996, 1997 and 2000, which would allow producers to avoid paying royalties.

"In our review of the methodology and assumptions used in MMS' [$60 billion] estimate, we found that MMS may have over-estimated the amount of oil and natural gas that would be produced from these leases over the course of their lifetime. MMS officials agreed with this assessment and said that an updated estimate of foregone revenue from these leases might be considerably lower than the $60 billion figure," the report said. The GAO said an updated figure would likely "differ significantly" from the original estimate of potential royalty losses stemming from the Kerr-McGee lawsuit.

The report pointed out that a loss in the Kerr-McGee lawsuit would not only affect recovery of royalties for the 1996, 1997 and 2000 leases, but it "would also impact the government's negotiation of price thresholds for the 1998 and 1999 leases." So far, Interior has negotiated new leases (that include price thresholds) with only six of 45 companies that hold 1998-1999 leases. The negotiated contracts require the producers to pay royalties on future production from the leases, but do not address the issue of recovery of royalties on past production.

The bottom line is "it is impossible to precisely estimate how much royalty revenue the federal government could lose as the result of the 1998 and 1999 leases that did not include price thresholds or if Interior loses the legal challenge to its authority to include price thresholds for the leases issued in 1996, 1997 and 2000, because of the inherent uncertainty of future oil and natural gas prices and production volumes," the GAO report noted.

In order to have "accurate and timely information" to consider legislative action to recover lost royalties, "we are recommending that MMS provide to the Congress 1) the status of the leases and the annual amount of royalties that have been foregone on the 1998 and 1999 DWRRA leases until the issue is resolved; 2) the status of the leases and annual amount of royalties collected to date from the 1996, 1997 and 2000 DWRRA leases until the Kerr-McGee suit is resolved; and 3) periodic estimates of future foregone royalties from 1998 and 1999 DWRRA leases and future royalties that may be at risk from 1996, 1997 and 2000 DWRRA leases until these issues are resolved," the agency said.

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