TAKING ROYALTIES “IN-KIND”: THE FEDERAL PROSPECTIVE

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 17C
TAKING ROYALTIES "IN-KIND": THE FEDERAL PROSPECTIVE
Bonn J. Macy
Minerals Management Service
Washington, D.C.

Special Assistant to the Director

U.S. Department of the Interior

The concept of taking natural resource royalties "in-kind" is not a new idea. In spite of its current buzz with industry it is centuries old. It is the most primitive form of the royalty concept itself. More than a thousand years ago when royal landowners found indentured servitude was not meeting their needs for raw materials, they contracted with independent miners to do it. The Miners, who were probably the leading entrepreneurs of their day, found the arrangements attractive. The contractual arrangement between royals and the miners was that the miners would be allowed to exploit the royal resources as long as they provided a share of the production to the Crown. These first royalties were clearly in-kind. The ancient Greeks, medieval Germans, Saxons, and Normans all took their royal share of mineral production from their lands in-kind. The concept of paying the royal owners "in-value" with cash for mining their lands is a much more modern construction. As economies grew and progressed, the gold, silver, copper, tin, iron, mercury, etc. that was mined became more valuable to the crown for what they could buy rather than for their practical uses. Over the broad sweep of time, shifting relative costs for labor, transportation, information, market access and financial transactions probably played a role in the move from in-kind to in-value royalty collection. That is to say, it become easier, more convenient and cheaper for the King to take cold cash over production.

Today both systems can be found in all corners of the world. The United States has long recognized the royalty in-kind option. All Federal leases contain a provision that allows the Secretary to elect to take the Federal royalty in-kind. Some versions of Federal leases over history actually gave the lessee the option to pay their royalties in-kind. Few, however, did. Over all these years it usually made sense for the government to take a cash royalty payment.

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Until now? Even the most casual observer will note the dramatic transformations in our economy over the last 25 years: computers, information, automation, telecommunications, financial services, deregulation, as well as the increasing complexity and sophistication of markets, and the commercial enterprises that operate in them. We all are repeatedly bouncing off satellites. The way the oil and gas industry does business today also has changed markedly. Transactions costs have declined, and assets can change hands several times a day. Real time market information is readily available to everyone. There is no doubt that changes to the economy over this time have shifted the relative costs of activities associated with mineral production, sale and royalty collection. These economic changes suggest that it is worth taking another look at the way the Federal government collects its royalties. Indeed, other countries are rediscovering the possibility of "in-kind" royalties. The Canadian Province of Alberta with their Crude Oil royalty in-kind program is one relevant example. Has the royalty issue in the US finally come full circle? Have all the economic factors re-aligned in such a way as to make taking royalties in-kind the efficient choice once again? Maybe. What MMS recognizes is that current conditions strongly suggest that we thoroughly examine the royalty in-kind (RIK) issue through analytical study and practical tests.

Since its inception in 1982, MMS has consistently sought to be an active and progressive steward of the Federal royalty interest. In keeping with the Administration's goal of re-inventing government MMS thought that the RIK concept might be an effective way of changing and improving the way the Federal government does business and should be studied. Given the changes in the economy and our commercial structures, will RIK allow us to do our job more effectively and at lower cost to the taxpayer? Can we eliminate a lot of unproductive administrative activity for both government and the companies we allow to extract oil and gas from Federal land? Is it more efficient? Perhaps.

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MMS is now entering the next phase of its examination of the RIK concept. The ground work has been laid over the last four years. From the planning and implementation of a pilot program in 1995, through a careful examination of that pilot's results, to a further study of the concept's feasibility, MMS is now prepared to implement three new RIK pilot programs. Before we discuss the planning of these new pilots, it is useful to go back and examine what we have done and what we have learned to date regarding RIK.

The 1995 Royalty Gas Marketing Pilot...