A former auditor for the Department of Interior’s (DOI) Minerals Management Service (MMS) Wednesday told a House committee that audits of oil and natural gas companies began to be deemphasized beginning in 2000, and enforcement of lease terms and regulations “seemed to become less important.”

Bobby L. Maxwell testified before the House Committee on Natural Resources, which held its second in a series of hearings on ongoing management issues at the Interior Department (see Daily GPI, Feb. 28). The oversight hearings are focused on MMS management issues exposed in recent investigations by the Inspector General and the General Accountability Office, including audit, compliance, royalty-in-kind (RIK) and state and tribal issues.

Maxwell gained notoriety after claiming he was fired after top DOI officials allegedly ordered him to stop pursuing Kerr-McGee Corp. for $12 million in back royalty payments (see Daily GPI, July 5, 2006). The DOI disputes Maxwell’s claims (see Daily GPI, Sept. 25, 2006). He told the committee that “around the year 2000, MMS began to change.” Instead of professional audits, he said MMS advocated “compliance reviews” instead.

“It was clearly stated that no dissent would be tolerated” concerning the use of compliance reviews instead of audits, Maxwell said. “With the new compliance system, we were told not to bother the oil companies. We were told not to be requesting documents as we formerly had with audits. Audit staff was reduced. Many auditors stopped traveling to companies for audits, stopped interviewing oil company staff, stopped visiting marketing departments and field personnel.”

By 2002, Maxwell said, “we were no longer allowed to audit certain areas. For example, we were not allowed to review or audit many royalty-in-kind contracts.” He said he was “ordered not to get any information from the RIK division of MMS or review their contracts for sale of the oil and gas.”

He said “pressure continued to mount” through 2003 to not pursue royalty underpayments to the U.S. government, including the Kerr-McGee case. Maxwell later filed a False Claims Act lawsuit against Kerr-McGee on behalf of the U.S. government to collect the underpayments, and within days of the lawsuit becoming public, he said he was notified he was being terminated.

Maxwell noted that he continued to pursue the lawsuit “on my own time and at my own expense.” In January, the U.S. District Court for the District of Colorado found Kerr-McGee guilty of underpaying $7.5 million in royalties and of failing to disclose relevant information on its royalties. Anadarko Petroleum Corp., which bought Kerr-McGee last year, is challenging the DOI about the lease payments (see Daily GPI, March 5).

“The root of your testimony, it seems to be, is that a dramatically different philosophy has taken root at MMS, and that philosophy is to not bother the oil companies,” said Committee Chairman Nick J. Rahall II (D-WV). “It boggles the mind that such a philosophy would take hold. It is something that the American people must know, they are deserving to know.” He asked Maxwell if there was a “benefit” to the United States to take a “hands off attitude.”

“I don’t understand the ramifications, but the whole culture changed dramatically,” Maxwell said. “There’s a definite place for compliance reviews, but you have to start with audits.”

Rahall said the MMS “seems to have drifted further and further into the grasp of the oil and gas industry,” and “at best, its performance might be described as slipshod.” He noted that the energy development function at MMS “has been running at full throttle. But when it comes to collecting the payment due the people, the agency has stalled.”

Specifically, Rahall slammed the RIK program, which was designed to allow energy companies to pay the government in product rather than in cash. “But this has become an elusive mess. For MMS, tracking money was hard enough, but following the flow of oil has proven to be slippery business indeed. By some accounts, the Royalty-in-Kind program has served as a giant loophole, allowing wealthy companies to forgo fair payment to the public.”

“By necessity,” he said, MMS works closely with representatives of the oil and gas industry. “But in far too many instances, that closeness has taken on the distasteful appearance of coziness. It is becoming clear that the agency has acted to the benefit of the industry and the detriment of the public. The recurring questions are: To what extent did it do so deliberately? How can it be fixed? And what can be done to prevent it from happening again?”

The committee called nine witnesses on Wednesday, led by C. Stephen Allred, assistant secretary at the DOI. Since assuming his post last fall, Allred said he has focused on correcting the faulty deepwater leases that were issued by MMS in 1998 and 1999. The faulty leases 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. However, the MMS left this language out of the 1998 and 1999 leases — a mistake that could cost the federal government $10 billion or more over the life of the leases if they are not renegotiated.

MMS Director Johnnie Burton testified last month that the agency is now negotiating with 22 producers concerning the faulty leases. Allred told the committee that “to date, we have reached agreements with six companies. This is significant, but we need more companies to sign agreements.”

To resolve the issue, Allred said he has adopted three basic principles: negotiate price thresholds in prospective leases; not give an economic advantage to one company over another; and amend the agreements to minimize litigation risks. But he said DOI would not be able to achieve success without cooperation from Congress.

Allred also warned the committee about what might happen if HR 6 is passed. The Democratic measure cleared the House by a vote of 264 to 123 in January (see Daily GPI, Jan. 19). Among other things, the legislation would force holders of flawed 1998-1999 offshore leases to renegotiate their contracts or pay a “conservation of resources fee” in order to bid on future government leases.

“If legislation addressed future lease sales, and if a judge were to enjoin future lease issuance for a period of time, the resulting impacts would be significant,” Allred said, mirroring last month’s testimony by Burton. “Litigation could take years to resolve.” With a three-year delay, he noted that production over 10 years would be reduced by 1.6 billion boe. The expected cumulative revenue decline over the 10-year period would be $13 billion.

However, Rahall appeared undeterred. He asked Allred several times whether the DOI planned to increase the number of audits it performed on oil and gas royalties.

“It does appear we’re getting ripped off, clear and simple,” said Rahall.

Allred said DOI planned to have more “risk-based” audits, but he was not sure whether there would be more specific audits concerning royalties.

“We haven’t completed our risk-based criteria yet,” he said. “Given the resources we have, we try to cover the largest population of royalty payers we possibly can. If we do just audits, we cover a much smaller portion of the population.”

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