Federal and Native American royalties did not keep pace with the escalating oil and natural gas prices between 2001 and 2005 largely because the production volumes on which royalties are based “declined substantially” during that period, according to a report issued by the Government Accountability Office (GAO) Friday. It also cited as a factor the drop-off in royalty rates due to the move away from shallow-water drilling in the Gulf of Mexico, where rates are higher, to the deepwater.

The report, which was requested by a number of Senate and House lawmakers, did not calculate the impact that royalty relief has had on the sluggish growth in royalties flowing to the federal government. The Interior Department’s Minerals Management Service (MMS) reported that natural gas production exempt from royalties grew from 5 Bcf in 2001 to 246 Bcf in 2005, for a total estimated royalty value of about $226 million, the GAO said. “Volumes of natural gas subject to royalty relief are expected to grow in the future,” said the agency, which is examining the government’s royalty-relief policies in a separate study.

In 2001, the GAO said 6.9 Tcf of natural gas was sold at an average sale price of $5.05/Mcf, fetching royalties of $5.06 billion that year for the federal coffers. But in 2005, the volume sold was significantly lower (5.86 Tcf) while the average sale price was higher at $6.59/Mcf. As a result, total gas royalties paid in 2005 were only slightly more than 2001 — at $5.3 billion, the agency noted.

The oil side told a similar story. In 2001, 699 million barrels of oil were sold in the U.S. at an average sale price of $25.27/barrel, bringing in royalties of $2.38 billion for the federal government, according to the GAO. The volumes sold, however, were much lower in 2005 (434 million barrels), while the average sale price rose to $47.96/barrel. Total oil royalties paid were $2.675 billion.

The “decreases in the volume of natural gas produced and sold between 2001 and 2005 have largely offset the impact of increased sales prices on total royalty revenues,” the GAO said. “Natural gas volumes from federal and Native American lands decreased because of natural declines in older wells. In addition, hurricanes in 2005 contributed to a decline in natural gas production volumes by forcing companies to temporarily suspend natural gas production from wells in the Gulf of Mexico,” it noted. Royalty relief for producers also contributed to the lackluster growth in revenues.

While total royalties from gas production rose by about $242 million between 2001 and 2005, the GAO estimated that the spike in gas prices should have increased potential gas royalties during the five-year period by $1.392 billion. “However, we estimate that a decline in the total natural gas volume sold resulted in a decrease of about $860 million in potential royalty revenues. In addition, a decline in the average royalty rate decreased potential royalty revenues by an additional $292 million,” it said.

“A significant portion of the $860 million decrease in potential royalty revenues associated with declining sales volumes appears to be the result of a decrease in natural gas production caused by the normal depletion of natural gas wells in shallow waters (waters less than 400 meters deep) in the Gulf of Mexico,” the agency reported.

MMS’ Gulf of Mexico Offshore Region first reported a “precipitous decline” in gas production in shallow waters in the Gulf in 1997, a trend that continued from 2001 through 2005. The MMS noted that shallow-water gas production fell to 2.4 Tcf in 2005 from 4.2 Tcf in 2001, while production in the deepwater (over 400 meters) remained relatively stable.

In contrast to lower production volumes in the offshore, the GAO said onshore gas production actually increased by 17% between 2001 and 2005 due to growing volumes from new wells. “Had this onshore increase not occurred, the $860 million decrease in potential royalty revenues associated with declining sales volumes would have been greater.”

The destructive Gulf hurricanes last fall were a key factor in the reduced royalty revenues as well, according to the GAO. The MMS estimated that total cumulative gas production of 196,481 MMcf was off-line in the Gulf last August and September. “We estimate that this production could have resulted in royalty revenues of about $208 million.”

On the oil side, “the oil volumes sold from federal and Native American lands declined principally because MMS took substantial volumes in-kind and used these volumes to fill the SPR [Strategic Petroleum Reserve], instead of receiving cash royalty payments or selling the oil and collecting revenue from royalty-in-kind sales,” the GAO said.

Between 2001 and 2005, total oil royalty revenues from federal and Native American lands rose by about $295, but the GAO calculates that the rise in crude prices should have increased potential royalty revenues by $1.69 billion. It noted that “a decline in the total oil volume sold during this same period resulted in a decrease of about $1,278 million in potential royalty revenues. In addition, a drop in the average royalty rate caused another $129 million decrease in potential royalty revenues.”

While most of the $1,278 million drop in potential royalties was due to transfer of oil to the SPR, the Gulf hurricanes contributed to the shortfall in potential revenues as well, according to the GAO. “We estimated that…shut-in [Gulf oil] production could have produced royalty revenues of at least $270 million” last August and September.

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