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Report: Oil Industry Held to ‘Honor System’

Offshoredrilling-300x200_6467.jpg
Offshoredrilling-300x200_6467.jpg

Mismanagement of the Dept. of Interior’s royalty-in-kind program has cost the government millions in revenues from oil and natural gas companies, according to a biting report released Wednesday. The Project on Government Oversight, or POGO, a watchdog organization that issued the paper, called for the abolition of the program, which has been the subject of a string of negative oversight reports.

These findings come even as the House on Tuesday approved a Democratic-sponsored bill to expand offshore oil drilling.

Environment_6468.jpg
Environment_6468.jpg

Illustration by:Matt Mahurin

The royalty-in-kind program, run by Interior’s Minerals Management Service, is the federal government’s biggest revenue source after income taxes. Since its creation a decade ago, its lack of transparency and ties to the oil and natural gas industry have set off alarm bells among congressional investigators and auditors at Interior.

Yet it was three reports issued last week by Interior’s inspector general that blew the lid off what is now considered a “culture of ethical failure” at Minerals Management Service — particularly in its royalty-in-kind program.

The inspector general reports spotlighted some employees at Minerals Management Service who broke government rules by accepting gifts and engaging in sexual relationships with employees of the oil and natural gas industry, among other things. One person cited was Gregory Smith, former director of the royalty-in-kind program. He allegedly partied with oil executives, accepted a consulting job that conflicted with his government work and made cocaine deals with his secretary.

The Project on Government Oversight’s report focuses on the inspector general’s troubling assessment that the energy industry has exploited the government’s royalty-in-kind program to drill on federally protected lands with little accountability. Energy companies self-report how much they drill. Companies can abuse the system by underreporting how much oil and gas they drill– and how much royalties the government should receive.

“The royalty-in-kind program exists to benefit the oil and gas industry to the detriment of the public,” concludes the report. A congressional hearing Thursday will further scrutinize the program’s industry ties.

But as Congress moves to expand offshore drilling, it’s unclear if the scandal-plagued federal program that manages drilling leases will be ended or reformed.

Interior created the royalty-in-kind program in 1998, and made it fully operational in 2004. Before it was launched, the Interior Dept. collected royalties from oil and gas companies “in-value” — meaning it received a percentage of their profits. Under “in-kind” royalties, Interior collects a portion, usually about one-sixth, of the oil and natural gas extracted by the companies leasing federal land.

Employees of the royalty-in-kind program are supposed to sell the oil and natural gas on the open market and turn the proceeds over to the U.S. Treasury.

In 2007, the program generated $9 billion — more revenue than that generated by “in-value” cash payments, according to the Bush administration, which has long supported “in-kind” royalties.

In 2001, the American Petroleum Institute, the industry’s trade association, wrote a memo to Vice President Dick Cheney’s notoriously secretive energy task force urging that the program “should be part of a comprehensive national energy strategy.”

But the Project on Government Oversight, with a catalog of glaring oversight problems, argue royalty-in-kind should no longer continue in its current form. For example, there is no third-party oversight of how many barrels of oil and cubic feet of natural gas companies extract from government land.

Instead, the oil and gas companies operate under an “honor system,” reporting their data and telling Interior what it owes in resource royalties. The program’s computer system is unable to track in a timely manner when industry doesn’t provide the agreed-upon royalties.

A report from the Government Accounting Office, the investigative arm of Congress, that examined Interior’s management of royalties, also released this week, effectively accuses companies of cooking the books by keeping “two sets of conflicting production data — one used by the company and one reported to Minerals Management Service.”

Just how much the government loses in revenue because of the royalty-in-kind program’s industry-friendly management is difficult to determine — because auditors don’t know how much oil and gas companies are extracting that is not being counted by Interior. But recent lawsuits against oil and natural gas companies suggest the amount of money involved.

Last Thursday, the 10th Circuit Court in Denver, where Minerals Management Service is based, found that Kerr-McGee, an energy company since acquired by the Houston-based Anadarko Petroleum Corp., withheld about $7.5 million in oil and gas resources from the royalty-in-kind program. The case was brought by Bobby Maxwell, a former Minerals Management Service auditor who quit the agency in disgust over its lack of oversight.

And in 2007, the Conoco Phillips subsidiary Burlington Resources Inc. agreed, in a case brought by the Justice Dept., to give the government $97.5 million in unpaid royalties.

A spokesman for the royalty-in-kind program declined to comment on the allegations made in the Project on Government Oversight report, instead referring to a statement from Interior Sec. Dirk Kempthorne in the wake of last week’s inspector general reports. “We will take swift action to restore the public trust,” Kempthorne said. “The [Minerals Management Service] will begin taking appropriate disciplinary actions.”

The inspector general’s reports of sex, drugs and largess from oil executives at Minerals Management Service were the rare government audits to make front-page news. They also provoked immediate reaction from lawmakers, including House Speaker Nancy Pelosi (D-Calif.). In a statement last week, she said, the “report documents the pervasive culture of exclusivity that has cheated the American taxpayer out of the billions dollars owed them by the oil companies.”

Yet Pelosi and House Democrats have not significantly rewritten proposed legislation that expands drilling to correct the alleged mismanagement at Minerals Management Service. The speaker did, however, call for a “very strong integrity piece” in the drilling legislation to deter future misconduct at the agency.

The House Committee on Oversight and Government Reform, which has investigated the royalty-in-kind program since the Clinton administration, has begged off holding hearings. The committee’s GOP leadership has called for it. But Rep. Henry A. Waxman (D-Calif.), the oversight chairman, said in a letter that while Interior Dept. mismanagement “epitomizes the close relationship between the Bush administration and the oil industry,” the House Natural Resources Committee has jurisdiction.

That committee is holding a hearing Thursday. Committee Chairman Nick Rahall (D-W.V.) has voiced support for expanded offshore drilling. He has also compared Minerals Management Service to a “television miniseries — and one that cannot air during family viewing time.”

With drilling legislation now heading toward the Senate, the agency and its royalty-in-kind program might not have much down time to clean up its act.

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