The U.S. Minerals Management Service has estimated California producers owe it about $440 million for underpaying royalties on federal royalty crude oil in 1980-94.
MMS is pursuing similar oil valuation issues arising in other states and on the Outer Continental Shelf and will propose new oil valuation regulations by yearend (OGJ, May 27, p. 26).
An interagency team reported last May California producers had underpaid onshore and offshore royalties because they often received gross proceeds from crude higher than the posted prices on which they paid royalties (OGJ, May 27, p. 26).
The team had estimated California producers could owe as much as $856 million, based on adjusted Alaska North Slope (ANS) crude oil prices during 1978-93.
But Cynthia Quarterman, MMS director, said that estimate was discounted to exclude revenues for 1978 and 1979, volumes of royalty taken in kind, crude oil production attributable to periods closed by settlement agreements, and for differences in valuation methods beginning Mar. 1, 1988.
Underpayments targeted
MMS said that since 1980 more than 100 firms have made royalty payments to MMS for federal crude produced in and off California, although 20 payors accounted for nearly 97% of federal production. Collection efforts will specifically target these 20 payors.
The agency said it would issue its first orders and bills within a few months and conclude its audits and billing efforts within a year after all data are received.
Quarterman said, "MMS will today issue audit or investigation engagement letters to the 20 companies involved and will immediately begin working with the state of California's controller's office and use information collected by the interagency team to determine the exact amount owed by the companies.
"We are committed to making certain all royalties owed are collected. We will continue to work towards that goal."
Quarterman told OGJ the data indicate firms undervalued crude by as much as $2-3/bbl for part of the period in question.
She said, "The large percentage of oil produced in California is never sold on the market. So you have a situation where you don't have the arm's length transaction and you are using the crude internally and valuing it on your own or someone else's posted prices."
Other states
MMS also is investigating similar oil valuation issues in other states and has told its auditors that premiums received by a lessee represent gross proceeds and are therefore royalty-bearing.
"Audit personnel also have been instructed to hold open the most recent audit period and to consider these oil valuation issues in all audits."
Quarterman said the California underpayments were easier to quantify because it is a closed market, but the situation is different for other states because crude is moved in and out more readily.
Nevertheless, she said MMS has noted a disparity between futures and posted prices and will look for possible undervaluation in the course of continuing audits, which can extend back 6 years.
Rep. Carolyn Maloney (D-N.Y.), who has been active on the undervaluation issue, praised MMS for moving "to get to the bottom of an outrageous situation that has been ripping off all American taxpayers."
She said, "I have received compelling evidence that oil in Texas, New Mexico, Louisiana, Wyoming, and a dozen other states has been undervalued.
"I hope that today's MMS statement will encourage the relevant oil companies to release the so-called 'proprietary documents' they have held back. If today's action is followed up with a release of these documents, we may be well on our way to getting to the bottom of the larger undervaluation problem.
"For over 20 years, oil companies have been buying low and selling high, pinching the American people at the pump and laughing all the way to the bank."
Rep. Maloney praised MMS for acting to pursue collection for the entire 1980-95 span and for using ANS spot prices for 1980-88 as the basis for billing oil companies. She said that time span represents about three fourths of the undervalued royalties.
She said, "Strong evidence shows that the oil companies themselves refer to ANS spot prices as the fair market value. What is good for the oil companies is good for the American taxpayer."
Audit procedures
MMS said its valuation procedures distinguish between arm's length transactions, typical of nonintegrated companies, and nonarm's length transactions, typical of integrated companies. Further, MMS rules were amended Mar. 1, 1988, to codify the differences.
It said when it audits integrated companies for periods prior to Mar. 1, 1988, the price for ANS crude (adjusted for quality and transportation) will be used to establish value for royalty purposes other than arm's length sales.
"For true arm's length sales, value will be based on gross proceeds, including any premiums. MMS will apply this approach immediately for the period Oct. 1, 1983, through Feb. 29, 1988-because it has more complete automated records for that period-and issue orders to pay. As soon as records for the Jan. 1, 1980, through Sept. 30, 1983, period are located and reviewed manually, additional orders will be issued."
MMS said for periods beginning Mar. 1, 1988, when it revised its crude oil regulations, audits of sample transactions will be conducted.
"For other than true arm's length sales, royalty valuation will be based on the higher of gross proceeds or the valuation benchmarks in the MMS regulations, which are based primarily on arm's length transactions in the field or area, including any premiums paid.
"True arm's length sales will be valued based on gross proceeds, including any premiums. All orders will exclude crude oil taken in kind by MMS and sold to small refiners."
MMS said since nonintegrated companies are presumed to have sold oil at arm's length, it is appropriate to use gross proceeds from their arm's length transactions to determine value.
"For these companies, audits will be conducted on a sample transaction basis for representative time periods from Jan. 1, 1980, to current periods. These audits will determine if the companies systematically paid royalties on less than arm's length gross proceeds.
"When underpayments are identified, orders to perform (to recalculate royalties correctly consistent with gross proceeds) will be issued. These orders will exclude crude oil volumes subject to price controls or for which royalties were taken in kind by the federal government and sold to small refiners."
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