CHAPTER 13 THE FEDERAL RIK PROGRAM: PARTNERSHIPS IN ROYALTY ASSET MANAGEMENTSTATUS, OPERATIONS, LEGISLATION, AND A LOOK TO THE FUTURE
| Jurisdiction | United States |
(Feb 2004)
THE FEDERAL RIK PROGRAM: PARTNERSHIPS IN ROYALTY ASSET MANAGEMENTSTATUS, OPERATIONS, LEGISLATION, AND A LOOK TO THE FUTURE
Deputy Program Manager
Royalty in Kind - Minerals Management Service
Denver, Colorado
V. Kenneth Leonard
Senior Manager, Upstream
American Petroleum Institute
Washington, D.C.
I. INTRODUCTION TO THE FEDERAL ROYALTY IN KIND PROGRAM
The Minerals Management Service (MMS) is entrusted with ensuring that all Americans receive a fair and appropriate return for oil, gas, and other minerals produced from Federal leased lands. MMS collects, accounts for, and disburses between $5 and $10 billion in mineral revenues to its recipients annually. Historically, most of these revenues have been received in the form of royalty in value (RIV) cash payments made by mineral development interests.
In recent years, the MMS has been opting to take and receive an increasing proportion of oil and gas mineral royalties in the form of royalty in kind (RIK) production payments. This is particularly true for the royalty asset stream generated from Federal oil and gas leases on the Outer Continental Shelf. This paper describes the background, current status, operations, legislative landscape, and future plans for this still emerging asset management approach for Federal oil and gas royalty management.
A. Background to Federal Royalty in Kind
Governing Federal statutes and oil and gas lease terms provide the Secretary of the Interior with two options for the collection of oil and gas royalties. Payments may be received either in the form of RIV cash payments or RIK production payments. These options present the MMS with the clear opportunity to improve the efficiency and effectiveness of its royalty management process. To leverage this opportunity, MMS is committed to the systematic and deliberate analysis of the Federal royalty portfolio to selectively apply each of these asset management methods to optimize returns and efficiencies for the taxpayer. The salient differences in the two approaches are:
Royalty in Value (RIV):
• Payment is made in cash by the lessee,
• The lessee disposes of production,
• The lessee calculates RIV payment and conducts royalty reporting,
• MMS accepts payment, subject to audit.
Royalty in Kind (RIK):
• The option is available only at the discretion of the lessor,
• Payment is made in physical production by the lessee,
• MMS disposes of production by competitive sale,
• Lessee only reports production; MMS assures full volume received,
• Value is determined by the market.
Benefits of the RIK option have been explored and realized by the MMS and include conflict avoidance, increased certainty and decreased administrative costs for the public and industry, earlier receipt of royalty revenues, potential revenue enhancement for the Treasury, and responsiveness to government mandated energy programs. Based on extensive experience to date, MMS has concluded that RIK is a viable option to deploy in the right circumstances, but is not appropriate for all lease production situations. As such, the use of both the RIK and RIV options in tandem is the asset management strategy adopted by the MMS.
. 1. Statutory Authority
The primary statutes that govern the receipt and disposition of oil and gas royalty payments in kind are the Outer Continental Shelf Lands Act (OCSLA) and the Mineral Leasing Act (MLA).
The OCSLA in relevant part states:
Sec. 27(a)(1): "%y all royalties or net profit shares or both accruing to the United States under any oil and gas lease issued or maintained in accordance with this Act, shall, on demand of the Secretary, be paid in oil or gas".
Sec. 27(b)(1) for oil and (c)(1) for gas: "%y the Secretary, pursuant to such terms as he determines, may offer to the public and sell by competitive bidding... for not less than its fair market value any part of the Ýoil / gas¨ %y obtained by the United States pursuant to a lease as royalty or net profit share %y".
The MLA in relevant part states:
Sec. 192: "%y All royalty accruing to the United States under any oil or gas lease or permit under this chapter on demand of the Secretary of the Interior shall be paid in oil or gas %y the Secretary may sell the current product (oil or gas) at private sale, at not less than the market price %y".
Additional authorities for the Federal RIK program have been contained in the Department of the Interior's appropriation authorities since Fiscal Year (FY) 2000, specifically:
"Provided further, that MMS may under the Royalty-in-kind pilot program use a portion of the revenues from royalty-in-kind sales, without regard to fiscal year limitation, to pay for transportation to wholesale market centers or upstream pooling points, and to process or otherwise dispose of royalty production taken in-kind."
2. Lease Terms.
Standard Federal oil and gas lease terms explicitly provide for the Federal lessor to take royalties in kind at its discretion, and provide further guidelines and rights, as the following example of standard offshore oil and gas lease language illustrates:
"...The Lessor shall determine whether production royalty shall be paid in amount or value...When paid in amount, such royalties shall be delivered at pipeline connections or in tanks provided by the Lessee. Such deliveries shall be made at reasonable times and intervals and, at Lessor's option, shall be effected either (i) on or immediately adjacent to the leased area, without cost to the Lessor, or (ii) at a more convenient point closer to shore or on shore, in which event the Lessee shall be entitled to reimbursement for the reasonable cost of transporting the royalty substance to such delivery point."
Standard onshore lease terms are similar, but do not include an option requiring the lessee to deliver royalty substances at locations away from the leased area:
"Lessor reserves the right to specify whether royalty is to be paid in value or in kind %y When paid in kind, production shall be delivered, unless otherwise agreed to by lessor, in merchantable condition on the premises where produced without cost to lessor."
B. Historical Context of the Federal RIK Program.
The Department of the Interior has managed an RIK program for eligible small refiners since the 1970s. This program, authorized pursuant to provisions of the MLA and OCSLA, has for decades provided small refiners with access to crude oil supplies that otherwise could have been difficult for these companies to obtain.
In the mid-1990s, MMS began exploring the potential for a more broadly applied RIK program to increase efficiencies, decrease conflict, and enhance revenues generated from oil and gas production royalties. A feasibility study conducted by MMS in 1997 documented that taking royalties in kind could, under the right circumstances, be revenue neutral or positive and administratively more efficient for MMS and its mineral lessees. Based on recommendations from this study, MMS established three pilot projects:
• Wyoming Crude Oil RIK Pilot Project: In 1998, MMS and the State of Wyoming initiated the first major RIK pilot project. The project involved the sale of crude oil of different qualities produced from Federal leases in the Powder River and Big Horn Basins of Wyoming. This pilot has evolved into a steady state program (now in its sixth year) in which crude oil from both Federal and state leases is sold in the same sales events that are jointly managed by the State and MMS.
• Texas 8(g) Natural Gas RIK Pilot Project: In 1998, MMS, in partnership with the State of Texas General Land Office, initiated this RIK pilot project. This project involved natural gas produced from Federal leases in the Texas 8(g) zone of the Gulf of Mexico. The goals of this project included mutual exploration of methods to market RIK natural gas to realize RIK benefits and to learn from the Texas General Land Office's long-standing experience in managing RIK programs. Today, the project continues this joint partnership with the State, and has since merged with the larger Federal natural gas RIK program in the Gulf of Mexico.
• Federal Gulf of Mexico Natural Gas RIK Pilot Project: In 1999, MMS initiated a large-scale pilot project to test the effectiveness of taking substantial volumes of natural gas in the Gulf of Mexico and selling these aggregated volumes in the open market. The project has succeeded in refining and evolving the methods and business cases for taking gas in kind, and is now in its fifth year of operation.
A notable event in the history of the Federal RIK program occurred in January 2001 with the publication of the MMS Director's RIK Road Map to the Future, a management action plan in which MMS formally adopted RIK as a permanent option to manage the Nation's mineral royalty assets. The Road Map set forth the strategic direction and presented actions to install the capability needed to transition the RIK option from pilot projects to operational activity over a 3-year period.
Another major event occurred in 2002 with the start of the largest MMS RIK program to date - the joint initiative with the Department of Energy to fill the remaining capacity of the Strategic Petroleum Reserve (SPR). This initiative, directed by President Bush to enhance the Nation's energy independence, began in April 2002 and has since ramped up to involve some 60 percent of Outer Continental Shelf crude oil royalties.
Calendar year 2003 has seen the implementation of three management information systems to support the permanent RIK program for natural gas, crude oil, and risk and performance management. Additionally, a new joint RIK pilot project was started with the State of Louisiana. Lastly, 2003 witnessed the start and substantial completion of a major effort undertaken by the MMS executive leadership to obtain an...
To continue reading
Request your trial