Interior Department’s Minerals Management Service (MMS) has quickly responded to a New York Times report that raised questions about whether the agency has been collecting sufficient royalties on natural gas produced from federal lands.

In a letter to House Resources Committee Chairman Richard Pombo (R-CA), MMS Director R.M. “Johnnie” Burton on Tuesday countered that the MMS has been recovering the proper amount of gas royalties from producers that it is permitted to collect under long-standing regulation, and has tightened its valuation audits of energy producers.

The Times article, published on Monday, alleged that out-dated royalty regulations — which require the agency to value royalties based on the lower wellhead price rather than the higher market price — prevented the federal government from taking advantage of the bonanza in natural gas prices in fiscal year 2005. It estimated that the MMS could have collected an additional $700 million in gas royalties last year for the federal coffers had royalties had been calculated using the higher market price for gas instead of the wellhead price.

“We, at the Minerals Management Service, base royalties on the value of the product at the lease [wellhead price] where the gas is produced, or, if you will, at the wholesale level,” Burton told Pombo. This is the value of gas minus the costs for transportation and processing of gas.

The Times pointed out while gas producers were reporting lower wellhead prices to MMS last year for royalty calculations, they were reporting significantly higher market prices for natural gas to the Securities and Exchange Commission (SEC) and their shareholders. “The price that companies are reporting to the Securities and Exchange Commission is akin to a retail price,” which includes transportation and processing costs, Burton noted.

For the first 10 months of 2005, the Energy Information Administration showed an average differential of $1.15/Mcf between the lease price and delivery price for natural gas at destination, “reflecting the type of difference one might expect to see between the prices reported to the SEC and the royalty values reported to MMS,” she said.

“The article alleges that we should have collected an additional $700 million in royalties. We assume this is calculated using the price reported to the SEC. The objection [in the article], therefore, is to the calculation of the value of the gas at the lease [to determine royalties], which is an approach that has been used for over 70 years and has been codified in many rules.”

The Times claimed that the amount of royalties collected for natural gas produced on federal lands has not kept pace with rate of increase in gas prices. In fact, it noted that while gas prices nearly doubled from 2001 to 2005, the amount of gas royalties recovered in 2005 ($5.15 billion) was less than the amount of royalties collected in 2001 ($5.35 billion).

In 2005, there were a “number of factors” that affected reported royalties, according to Burton. “One issue is related to Hurricanes Katrina and Rita. Companies with New Orleans-based operations were unable to submit the required royalty reports at the end of August and September due to hurricane damage…They will appear in the FY 2006 data when the reports were received, rather than with the FY 2005 data, thereby making 2005 royalty collections appear to be less than what we will actually receive for 2005 production,” she said.

“Another reason royalties have not increased as quickly as gas prices is that a large share of production from federal leases has shifted to properties with lower royalty rates,” Burton noted. “Over the past few years, a greater proportion of federal production has come from deep-water Gulf of Mexico leases and onshore leases, where royalty rates are typically [the lower] 12.5%, while gas production from the shallow-water offshore leases, where the royalty rate is 16.67%, has fallen.” She said that since 1990 gas production in the shallow waters of the Gulf has fallen by more than half.

Burton also cited the increased royalty relief from Congress as a factor. “In order to encourage companies to invest in high-risk areas, Congress enacted the Deep Water Royalty Relief Act of 1995, which allows for certain volumes of deep-water oil and gas to be produced royalty-free. Although today most of that production is not enjoying any royalty-free volumes due to the high market prices, leases issued in 1998 and 1999 are not subject to a price threshold cap and are still enjoying royalty relief,” she said.

Burton further refuted claims that the agency’s royalty auditing practices were lax. “In FY 2005, 129 new audits were completed in addition to 376 old audits that were caught up and completed, for a total of 505 audits.” She estimated that a total of 3,395 properties were reviewed for compliance last year. In addition, the Bush administration “asked us to tighten our audit and compliance cycle from a five-year cycle to a three-year cycle.”

Due to the expansion of the agency’s royalty-in-kind program, which allows producers to pay their royalties with product rather than cash, MMS has been able to carry out more audits with less auditors, Burton said. “We are now taking 80% of the royalty oil and 20% of the royalty gas in the Gulf of Mexico in kind. Since this oil and gas is sold by MMS, there are no cash royalty payments from producing companies, and therefore no need for valuation audits and accompanying litigation for this production. This program, along with the efficiency gains…, has allowed us to reduce the number of auditors on staff.”

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