Mistake may have cost U.S. $7 billion in oil, gas royalties

Thursday, March 2, 2006

WASHINGTON -- An error has allowed oil and gas companies to avoid paying federal royalties on hundreds of offshore leases issued in the late 1990s, an Interior Department official said Wednesday.

One lawmaker said the mistake could cost the government $7 billion in revenue over the life of the leases and called for an investigation to see if the unexplained change in lease language might have been deliberate.

Congress in 1995 exempted companies from royalty payments for oil and gas taken from leases issued in the deep waters of the Gulf of Mexico, but also required that the royalties be paid if oil or gas prices reach a certain threshold. Now that prices have soared well above the threshold, royalties should be paid on many of the leases, which still have decades to run.

But the threshold provision "was inadvertently dropped" from an addendum attached to more than 1,100 leases issued by the department's Minerals Management Service in 1998 and 1999, allowing the companies to avoid royalty payments for years to come, an agency official told a hearing of the House Government Reform subcommittee on energy and resources.

"We have not been able to ascertain who pushed the button" that made the changes in the lease language, said Walter Cruickshank, deputy director of the Minerals Management Service. He said a person -- not a computer -- would have had to make the change, but there was no agency decision to remove the threshold language from the leases.

At the time, Cruickshank said, "everyone knew the [price] threshold applied," even though prices were well below the threshold. The royalty relief was embraced by Congress and the Clinton administration as a way to promote deep-water oil and gas development.

Rep. Darrell Issa, R-Calif., the subcommittee chairman, said the changes made in the 1998-1999 leases are "suspicious" and he is not ready to accept that they were simple mistakes.

He said he planned to seek more documents from the agency and said the issue may need to be investigated by the Justice Department to determine whether there was any deliberate wrongdoing.

"This is a $7 billion word processing error," Issa told reporters. He said some of the leases issued during those two years could remain in effect for as long as 85 years, so the government will be unable to collect royalty payments from oil and gas taken from those leases for decades to come.

The price threshold where royalties must be paid changes yearly. Most recently it was set at about $34 a barrel for oil and $4.34 per thousand cubic feet for natural gas, according to Interior officials. The price of oil Wednesday on the New York Mercantile Exchange was nearly $62 a barrel and the government estimates it will remain in the $50-a-barrel range for years to come. Natural gas prices have been in the $9-per-thousand-cubic-feet range.

Cruickshank said he had no explanation for why the threshold requirement was taken out of the lease language when an addendum was changed in 1997 to reflect other regulatory changes. "It is clear that there is no record telling people to take the language out," he told reporters after hearing.

While providing no specific number, Cruickshank said the government already has lost "several hundred million" dollars in royalty payments from the 1998-99 leases. If prices remain high, lost royalties "will be in the billions of dollars", he acknowledged.

The mystery surrounding the 1998-99 leases is part of a broader question over whether any royalty relief should be given to the industry, given high oil and gas prices and huge industry profits.

The Interior Department estimates that as much as $66 billion worth of oil and natural gas that will be taken from the Gulf of Mexico between now and 2011 falls under the royalty relief law enacted by Congress in 1995. Much of that oil and gas will be subject to royalties under the price threshold provision, which is included in leases other than those issued in 1998-99.

Several oil and gas companies have challenged the legality of the threshold requirement in leases issued before 2001. Kerr McGee, a major natural gas producer, has given notice to the Interior Department that it will soon file a lawsuit arguing that the threshold provisions are illegal.

The Interior Department will "vigorously defend" the ability to impose royalties under a price threshold provision, said Cruickshank. "There's a lot of money at stake."

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