The omission of price thresholds in the 1998 and 1999 deepwater Gulf of Mexico oil and natural gas leases is “an example of bureaucratic bungling” at its worst, and the failure by Minerals Management Service (MMS) employees to report the oversight to superiors when they first detected it in 2000 stems from a “culture of irresponsibility” that pervades the Interior Department agency, Interior Inspector General Early Devaney told a House Government Reform subcommittee last Wednesday.

In his much-anticipated testimony before the Energy and Resources Subcommittee, Devaney painted a picture of a department that is out of control. “Short of a crime, anything goes at the highest levels of the Department of Interior,” he said during the fourth and final oversight hearing of the subcommittee, which for seven months has been investigating the details surround the missing price thresholds. This oversight by Interior’s MMS is projected to cost the federal government upwards of $10 billion over the life of the leases, according to the Government Accountability Office.

“Ethics failures on the part of senior department officials — taking the form of appearances of impropriety, favoritism and bias — have been routinely dismissed with a promise [of] ‘not to do it again,'” Devaney said. “I have watched a number of high-level Interior officials leave the department under the cloud of [Office of Inspector General] investigations into bad judgment and misconduct. Absent criminal charges, however, they are sent off in usual fashion, with a party paying tribute to their good service [and] wishing them well.”

Despite the “egregious loss of revenue to the taxpayer,” Devaney said the blunder by MMS employees with respect to the price thresholds in deepwater oil and gas leases in 1998 and 1999 does not rise to the level of criminal activity. “There isn’t anything that would allow us to take this case to a criminal attorney,” he noted.

He indicated that, as part of his final report, he may recommend disciplinary action against the employees who were responsible for the removal of the price thresholds in the 1998 and 1999 leases, as well as those who were aware of the oversight but failed to report it to their superiors. So far, no employees have been fired or disciplined for the matter, he said.

The lease price thresholds cut off royalty relief to producers when oil and gas prices are too high. Without this cut-off point in the 1998 and 1999 leases, the producers have escaped paying royalties on production up to a specific volume limit. The price caps were included in leases that were negotiated in 1996, 1997 and 2000, but were not in the 1998 and 1999 leases due a mistake on the part of the MMS. Congress has put pressure on producers to renegotiate these leases with the MMS.

“The [MMS] person responsible for directing the preparation of the leases said he was told by those in MMS’ Economics and Leasing Divisions to take the price threshold language out of the leases. This individual submitted to a polygraph and passed,” Devaney told the House subcommittee. Those in the Economics and Leasing Divisions “denied doing so.” However, they weren’t as willing to be polygraphed, he said.

“One of these individuals provided a sworn statement, submitted to a polygraph and passed. Another individual refused to provide a sworn statement, so was not asked to take a polygraph. [A] third individual provided a sworn statement, but refused to take a polygraph.” There’s “less of a cloud” of suspicion over those willing to give a sworn statement and submit to a polygraph, Devaney said.

Also passing a polygraph was Chris Oynes, regional director of MMS’ Gulf of Mexico office, who testified in late July that he had “no recollection” of Chevron U.S.A. executives alerting him to the missing price thresholds on at least two occasions in the late 1990s, Devaney noted. He said he didn’t dispute the account of the Chevron executives, saying it would be accepted at face value.

“Although we have found massive finger-pointing and blame enough to go around, we do not have a ‘smoking gun.'” Devaney said. “In the end, unless we come across something entirely unexpected, this appears to be an example of bureaucratic bungling, of the stove-piping of various responsibilities involved in a complex undertaking, [and] reliance on a …process which dilutes responsibility and accountability by including virtually every official involved, having no one person ultimately responsible for the quality assurance of the final product,” he noted.

“We found a brief flurry of e-mail discussion in 2000 about the discovery of the omission of price thresholds, and the e-mails document the decision not to advise the director” of MMS at the time about the missing price ceilings, he noted. “Unfortunately, the official [an associate director of MMS] who made this particular decision is deceased. We did not find any e-mail prior to 2000 that touched on this issue,” Devaney said. “I’ve been in this town a long time and it never ceases to amaze me how people get involved in a cover-up.”

Devaney said his office interviewed several former MMS directors who were in office at the time the price thresholds were omitted and at the time of the discovery of the mistake in 2000. “Each told us they only became aware of the omission [this year].”

If the oversight had been reported to the head of MMS when it was first discovered in 2000 — when no wells were yet producing on the 1998 and 1999 leases — there would have been no loss of revenues to the federal government and no need for the House hearings, said Rep. Darrell Issa, chairman of the Energy and Resources Subcommittee that has been at the forefront of the probe into the missing price thresholds. Devaney agreed with the observation.

Issa said the “central issue” from Devaney’s testimony was the cover-up of the missing price thresholds at Interior. The department made an “affirmative action” not to notify its supervisors of the mistake, which caused a “$10 billion-plus wound.” The public will not accept “the wink and the nod that that was just a mistake,” he noted.

Based on past experiences, Devaney said he had doubts about whether Interior will accept any recommendations that his office makes in the wake of this massive error. “I have observed one instance after another when the good work of my office has been dynamically disregarded by the department.” He cited one example of a “particularly contentious” investigation of a high-level Interior official that he hoped would change the “ethical culture” of the department. Devaney said his hopes were quickly dashed when former Interior Secretary Gale Norton “indicated that she accepted this official’s admission that he exercised bad judgment, but given his promise [of] not to do so again, she was unwilling to take any action against him.”

Devaney said he has told Interior Secretary Dirk Kempthorne that he plans to write a white paper that will provide a “road map on how we [can] get out of this mess.” He noted that Kempthorne has sent two message to employees since taking office about following proper ethics and instructing all employees to cooperate with Devaney’s probe into the missing lease price thresholds.

At a follow-up hearing by the full Government Reform Committee last Thursday, MMS Director Johnnie Burton said the agency was actively negotiating with 10 producers who hold the royalty-free leases to correct the oversight that is costing the federal government billions of dollars. It’s estimated that 55-56 producers ranging from Amerada Hess to Woodside Energy still own royalty-free deepwater oil and gas leases in the Gulf of Mexico.

Shell is “ready to sign” a new agreement that would include price thresholds for 1998 and 1999 leases, and BP is “close behind,” she told the committee. Burton declined to identify the other eight producers, saying that they had not given the MMS the authority to disclose their names.

All told, she said that 20 producers have contacted the MMS about potentially renegotiating their 1998 and 1999 leases. “What I don’t know at this point is whether the others…did not contact us [because] their leases have been relinquished” or expired, Burton noted.

Committee Chairman Tom Davis (R-VA) asked Burton to provide the committee with an inventory of which companies are renegotiating their leases, the number of leases involved and when they will expire.

The committee’s investigation has focused on an estimated 1,100 leases that were issued without price thresholds in 1998 and 1999. Of those, Burton estimated that 700 leases still are active, with “probably a fairly good amount” held by the 10 producers who are renegotiating.

About 17 oil and gas leases that lack price thresholds currently are producing in the Gulf of Mexico, and roughly 27 leases have indicated discoveries, but the MMS doesn’t know whether they will be producible or not, Burton said.

Burton assured Davis that the MMS was “working hard” to recover the royalty revenues that are owed the federal government. Given the amount of money at stake, Davis warned that Congress would take action if the MMS fails to renegotiate the royalty-free leases.

While Interior wants to recover the royalty revenues, it is opposed to forcing producers to come to the negotiating table, said P. Lynn Scarlett, deputy secretary of Interior. “It’s very important that we uphold the sanctity of…contracts,” she noted. The department is relying on producers to voluntarily renegotiate their lease contracts.

This rankled Rep. Edward Markey (D-MA), who said he thought the Bush administration should put its “thumb on the scale” to even out the negotiations. He believes a proposal, sponsored by him and Rep. Maurice Hinchey (D-NY), would be a sufficient “stick” to get producers to the bargaining table. The proposal, which was passed by the House in May as part of the Interior spending bill for fiscal year 2007, would foreclose producers from bidding on future leases if they refuse to renegotiate their 1998 and 1999 royalty-free leases. The Senate has adopted a similar measure.

The Bush administration opposes the Markey/Hinchey measure. “We do have concerns…about any actions that would directly undermine contracts,” said Scarlett. She noted that if Interior refused to abide by the terms of the 1998 and 1999 contracts, it could affect the ability of the entire federal government to negotiate contracts in the future.

Rep. Issa also opposed the Markey/Hinchey proposal, saying he didn’t think the solution was fair. He said he believes the debacle over the price thresholds will be resolved, not by force, but by example. “If one company signs [a renegotiated lease], that will be the model for all of them.”

The 1998 and 1999 leases “are only a small part of what’s wrong with Interior,” said Rep. Henry Waxman (D-CA). The MMS “may actually be collaborating with industry to discourage auditors from collecting royalties,” he charged. “This looks like an agency that has been captured by the industry [that] it is supposed to be overseeing… There are serious problems at the top” of Interior.

Rep. Carolyn Maloney (D-NY) called Devaney’s testimony “tremendously disturbing,” noting that the MMS was a “revolving door,” with half of the people from the oil and natural gas industry. She went as far as to call for the abolishment of the department, with its oversight function to be moved elsewhere in the federal government.

In still yet another development last week, the MMS confirmed that two of six deepwater leases underpinning the potentially large Gulf discovery that was announced by Chevron Corp., Devon Energy Corp. and Statoil ASA earlier this month (see NGI, Sept. 11) do not include price thresholds, which would make a certain volume of production from these leases royalty-free despite high energy prices.

The House Government Reform’s Energy and Resources Subcommittee raised the possibility that some of the leases from the significant Gulf discovery may not have included price thresholds, and thus would be exempt from royalties, in a recent briefing memo. The issue of the missing price thresholds “is a matter of paramount concern in light of Chevron’s recently announced new discovery in the [Outer Continental Shelf] Gulf of Mexico region that may include leases signed in 1998 and 1999,” said the subcommittee memo.

The Gulf discovery, in the emerging Lower Tertiary trend, could hold 3-15 billion barrels of crude oil and large natural gas reserves as well. Interior declined to estimate the potential loss of royalty revenues from the two leases. “We’re not at the point where that can be assessed,” Davaney said.

Rep. Markey estimated that Chevron and the other producers could escape royalties on 87.5 million barrels of crude oil on each of the two leases that lack price thresholds. He did not offer figures on potential royalty-free gas production.

MMS spokesman Gary Strasburg confirmed that two of the leases were for partial blocks that were negotiated in 1998 and did not contain price thresholds. However, four leases were for complete blocks that were negotiated in 1996. These leases included price thresholds and would be subject to royalties.

The large Chevron-Devon-Statoil discovery occurred on the four complete blocks that stem from the 1996 royalty-bearing leases, Strasburg said. But “even though the discovery came from the four blocks, there is a possibility that part of the [find] may have also come from the partial blocks” that involve the 1998 royalty-free leases, he noted.

Chevron is the among the oil and gas producers that have been in talks with MMS to renegotiate their 1998 and 1999 oil and gas leases.

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