Royalty oil shipments vulnerable to fraud, IG finds

Nearly 30 percent of the contracts reviewed in an Energy Department inspector general audit of oil shipments to the Strategic Petroleum Reserve between 2002 and 2005 contained discrepancies between the amounts of oil reportedly shipped and the amounts received. In many cases, shipping and receiving contractors were the same companies or subsidiaries of the same corporate parent, increasing the risk of fraud, Inspector General Gregory Friedman reported earlier this month.

Since 2002, the Interior Department has shipped more than 112 million barrels of royalty oil valued at $4.4 billion to the strategic reserve, which is controlled by the Energy Department. Interior administers a royalty-in-kind program that allows energy producers operating in the Gulf of Mexico to pay production royalties owed the federal government in oil rather than cash, and the government has been using royalty oil to fill the reserve.

The Strategic Petroleum Reserve was created in 1975 as a hedge against disruption in oil supplies. The 2005 Energy Policy Act directed Energy to boost the reserve from 727 million barrels of oil to 1 billion barrels. Friedman said his office initiated the audit to evaluate the program's effectiveness because the value of royalty oil is so significant and the strategic reserve so critical to national security.

The way the program is set up, Interior's Minerals Management Service transfers royalty oil to Energy at specific terminals referred to as market centers. But auditors found that shipments scheduled by MMS didn't always match contractor-claimed receipts at the market centers.

What's more, both agencies use contractors to deliver and receive the oil, and in some cases the same companies were responsible for delivering and receiving the same shipments -- a fact of which Energy officials were unaware.

"Contractors acted as both shipping agent for MMS and receiving contractor for [Energy] in about 20 percent of the oil transfer contractor relationships reviewed," the IG reported. "We also identified two instances where the oil platform operator who owed royalty oil to the government, the MMS shipping agent, and the [Energy] receiving contractor were subsidiaries of the same organization."

"These relationships increased the risk that errors would not be detected . . . [and] could increase the contractors' ability to influence the transaction for their benefit," the IG found.

While the IG reported no evidence of fraud, Energy was not able to demonstrate that it had actually received all the oil shipped by MMS: "For example, a discrepancy between scheduled shipments and reported receipts of 32,000 barrels of oil, valued at about $1 million, remained unresolved."

Oil receipt documentation provided by contractors included spreadsheets without source documentation, unsupported handwritten changes to pipeline operator reports that recorded oil transferred at market centers, and pipeline statements that included caveats against their use for accounting purposes.

In a memo responding to the IG's findings, William Gibson, project manager for the Strategic Petroleum Reserve, concurred with the IG's recommendations for strengthening management of royalty oil receipts.

Energy now is requiring contractors to provide better supporting documentation and has formalized requirements for comparing those records with documentation contractors provide Interior to assure mutual agreement on the quantities of oil transferred between the agencies at market centers.

In addition, "The [reserve] plans, by March 31, 2008, to expand the scope of its annual crude oil accountability audit to include the market center royalty oil transfers, with particular focus on the related-party transactions," Gibson wrote.

Energy will work with Interior to resolve all discrepancies by Sept. 30, he wrote.