Statement of
Patricia Fry Godley
Assistant Secretary for Fossil Energy
U.S. Department of Energy
to the
Subcommittee on Military Readiness
Committee on National Security
May 7, 1997

Mr. Chairman and Members of the Subcommittee:

Just over 15 months ago, Congress in the 1996 National Defense Authorization Act authorized the Department of Energy to undertake a number of tasks to maximize the value of federal assets that make up the Naval Petroleum and Oil Shale Reserves. Today, I am pleased to report to the Subcommittee that we have made considerable progress in accomplishing those tasks:

The Elk Hills Divestiture

The Department remains on pace to complete the divestiture of the government's portion of the Elk Hills oil and gas field by the statutory deadline of February 10, 1998.

We have taken several steps in the last year to ensure that the best interests of U.S. taxpayers are met in the divestiture:

Retention of Divestment Advisors and Preparation of Sales Strategy. In accordance with the statutory direction, we have retained an divestment counseling team made up of C.S. First Boston and Petrie Parkman & Company. This team has assisted the Department in preparing a "segmentation" strategy that will permit all qualified bidders to compete on an equitable basis.

In an official notice soliciting bids, which we expect to issue within the next few weeks, we intend to offer two types of interests in the government's share of the Elk Hills property:

First, a single "operating working interest" that represents approximately three-quarters of the federal government's interest in the field. (The government is currently entitled to approximately 78 percent of the production from the entire field, while Chevron USA Production Company is entitled to the remainder.) The purchaser of the "operating working interest" will have clear right to at least 51 percent in each of the field's productive zones, ensuring that there will be no question over which owner holds a majority interest in the field after the sale.

Second, DOE will offer the government's remaining interest in 2-percent "non-operating working interests," which will provide an opportunity for many small and mid-size producers, refiners, and other prospective buyers to participate in the competitive sales process. Additionally, we have not dismissed the possibility that a portion of the government's interests could be packaged in ways that would appeal to institutional investors, if this would help maximize value to the United States.

We have announced this segmentation sales strategy to the public, and to date, have received very positive responses to our approach. We believe it will broaden considerably the universe of potential buyers, increase competition and, ultimately, ensure that taxpayers receive the highest value for the property. While we have worked hard to ensure that all qualified prospective bidders have the opportunity to participate in the sales process, we will not preclude qualified bidders from submitting offers on one, some, or all of the interests being sold. Again, our goal is to maximize and receive the highest value possible for the property, whether it is the sum of bids from multiple companies, or the composite of bids from a single company.

Independent Assessors Now at Work. One of the key safeguards established by Congress in the statute was the use of five independent assessors in establishing a minimum acceptable sale price. The legislation directs the Department to average the valuations prepared separately by the five assessors and to set a minimum sales price no lower than the average of the five or the average of the middle three, whichever is higher.

In recent weeks, we have contracted with the five firms that will carry out the independent valuations. They are: Miller and Lents, Ltd. Houston, TX; the Scotia Group, Inc., Dallas, TX; S.A. Holditch & Associates, Inc., New Orleans, LA; Ernest & Young LLP, Washington, D.C.; and Gaffney, Cline and Associates, Dallas, TX.

These five firms will work over the summer to assess the value of the Elk Hills field to the U.S. Government. We have purposely scheduled the completion of their valuations to coincide with the submission of bids by prospective purchasers to assure that both assessors and bidders are working under the same market conditions. This will allow us to make a more direct comparison between assessed values and bids.

As we have stated previously, the Administration will proceed with the sale only if the divestment of the Elk Hills property is more than the minimum price and the net present value of continued government ownership, taking into account all relevant economic factors.

Independent Reserve Report Completed. A key part of virtually all commercial petroleum property transactions is the preparation of an independent assessment of the remaining recoverable reserves in the field. This report is made available to prospective buyers and provides an unbiased, third-party analysis that all bidders can use in preparing their offers. Last year, we retained Ryder Scott Company, a highly-respected petroleum engineering firm, to prepare an independent reserve report for the field. This report has now been completed and will be made part of the data package available to prospective purchasers.

In short, Mr. Chairman, we have now completed virtually all of the steps necessary to begin the formal sales process. Meanwhile, we are continuing our discussions with Chevron to redetermine the final split in the ownership of production from each of Elk Hill's currently productive zones.

Disposition of the Other Petroleum Reserve and the Naval Oil Shale Reserves

The Naval Petroleum and Oil Shale Reserves also include three properties set aside in Colorado and Utah originally to provide a potential source of shale oil for the military, and two other petroleum fields -- the Teapot Dome field in Wyoming and the Buena Vista Hills field in California adjacent to Elk Hills. In the 1996 National Defense Authorization Act, Congress directed the Secretary of Energy to conduct a study to determine which of the following options, or combination of options, would maximize the value of these properties to the United States:

• Retention and operation of the reserves.

• Transfer of all or part of the reserves to another federal agency.

• Transfer of all or part of the reserves to the Department of the Interior for leasing in accordance with the Mineral Leasing Act and surface management in accordance with the Federal Land Policy and Management Act.

• Sale of the United States' interests in the reserves.

The Act also directed that an independent petroleum consultant be retained to conduct the study.

The Department of Energy contracted with John Gustavson and Associates to carry out the statutorily-directed study. In December 1996, Gustavson and Associates submitted its report to the Department of Energy, which then, in coordination with the Office of Management and Budget, began an inter-agency review to develop an Administration position and recommendations to the Congress. In April, the Department submitted its recommendations to Congress.

Teapot Dome Naval Petroleum Reserve. We recommend that the Department of Energy retain the Teapot Dome field is consistent with the view of the independent consultant. The average well at Teapot Dome produces just over 4 barrels of oil per day; total production is about 1100 barrels per day from about 420 producing wells. Over 40 percent of the field's production is coming from enhanced oil recovery. At this point in the life of the field, divestment costs would likely offset any revenues the United States would receive in a sale, especially if the Government is required to conduct a full environmental impact statement prior to a sale.

Also, DOE has set up the Rocky Mountain Oil Field Test Center at the site which is being used by both government and industry to test new oil field technologies, products and services. We believe that, in the remaining years of productive life of the field, this test center may continue to offer value to the oil and gas industry as a site where new enhanced recovery techniques, environmental compliance methods, and innovative production tools and processes can be tested. Accordingly, DOE is in the process of exploring this defederalization opportunity as an additional option for the disposition of the Teapot Dome Naval Petroleum Reserve.

Buena Vista Hills Naval Petroleum Reserve. The Buena Vista Hills Naval Petroleum Reserve in California is a "checkerboard" pattern of government- and privately-owned tracts. Of the 50 tracts owned by the Government, nearly 90 percent are leased by private oil companies. The unleased acreage includes eight half-block lots in Ford City which are probably too close to urban development to be used for oil and gas production or for agricultural use.

Our recommendation is to transfer the producing acreage to the Interior Department which would continue to oversee the existing mineral lease agreements. The Ford City lots would be sold. Gustavson and Associates recommended that all the Government property be offered for sale and estimated that such a sale would return about $6 million to the Treasury -- or about $1 million more than transfer to the Interior Department and the continuation of current leases.

Gustavson assumed that the transaction costs of such a sale to the Government would be only $300,000, based on costs typical of those in a private sector sale. However, as the Elk Hills divestiture has shown, the Government would likely incur costs that would not be typical of a private sector transaction, including the costs of environmental assessments. It is likely that actual sales costs could be the range of $500,000 to $800,000, thereby reducing the net revenues to the Government to perhaps as low as $500,000. Moreover, the relatively small monetary gain from a sale of the Buena Vista Hills tracts would not offset the potential lessening of environmental protection on the property. Transferring ownership to a private sector buyer(s) would carry with it the responsibility to comply with certain environmental requirements; however such obligations for a Federal agency are of a higher magnitude than those incurred by private owners. Transfer to the Interior Department would ensure that these rigorous standards for environmental protection are maintained.

The Naval Oil Shale Reserves (NOSR). Although originally set aside for their holdings of rich deposits of oil shale, these properties have remained largely undeveloped because of the uneconomic costs of producing oil from shale. The two shale reserves in Colorado -- Naval Oil Shale Reserve No. 1 and No. 3, both near Rifle -- are in a region where natural gas is produced commercially from nearby tracts. Since 1985, DOE has drilled several gas wells near the boundary of Naval Oil Shale Reserve No. 3 to protect government-owned gas resources from being drained by adjacent private operations.

The Naval Oil Shale Reserve No. 2 is in a remote area of Utah southwest of Vernal. It also has shown geologic potential for oil and natural gas production, although the acreage's hydrocarbon potential is still unexplored.

Gustavson and Associates recommended that the three oil shale properties be offered for sale, although it indicated that the total value of the option for leasing by the Interior Department .was about the same as the sale option.¹ Gustavson's recommendation to sell the properties, rather than have the Interior Department lease them, was based largely on the fact that under the Mineral Leasing Act, the States in which Federal land is located receive 50 percent of revenues from federal leases. Gustavson recommended the sales option because, when the revenues that would go to Utah and Colorado were subtracted, the sales option produced the highest value to the Federal Government.

DOE, however, reasoned that Congress had found public value in assigning the 50 percent interest in Federal royalties to States when it included that provision in the Mineral Leasing Act. DOE interpreted Congress' direction in the Defense Authorization Act to "maximize the value of the reserves to the United States" as a direction to consider the full value of both Federal and State revenues in the leasing option. When both values were included, the financial returns that might be expected by either the sale or leasing option were almost the same.

Furthermore, under the Interior Department's leasing program, the large expanses of undeveloped acreage in the Naval Oil Shale Reserves (which would be heavily discounted by potential buyers under the sale option) could be explored while still under Federal ownership. This would provide a more accurate valuation of the properties' future mineral value and allow the Federal Government to realize the full potential value of this undeveloped acreage.

The Department also went beyond monetary considerations in recommending the transfer of the properties to the Interior Department. Certain areas of the Reserves have considerable non-economic value. For example, there are areas within the Naval Oil Shale Reserves, particularly in Naval Oil Shale Reserve No. 2 in Utah, which hold cultural significance to Native American tribes. Similarly, the Green River runs through the Naval Oil Shale Reserve No. 2, and it like the other shale reserves, holds significant recreational value to the public. These ecological and cultural values outweighed the relatively small, near-term financial gain that a sale might produce.

Future Steps for the Non-Elk Hills Properties. The next step in implementing the Administration's recommendations for the properties other than Elk Hills is for legislation to be enacted by the Congress. The Administration intends to submit legislation in the near future. Such legislation would:

• Authorize the transfer of Naval Petroleum Reserve No. 2, Buena Vista Hills, (other than Ford City lots) to the Department of the Interior for leasing and surface management under the Mineral Leasing Act, Federal Land Policy and Management Act, and other applicable statutes, subject to the terms and conditions of the existing mineral leasing agreements, and subject further to a prior determination of the appropriate allocation of responsibility, if any, for environmental remediation and restoration. Pending such determination, DOE would retain and continue to operate the property under the Naval Petroleum Reserve law.

• Authorize DOE to undertake to sell or otherwise dispose of the United States' interest in certain lots in Ford City within NPR-2.

• Authorize the transfer of NOSR-1 (Colorado) and NOSR-2 (Utah) to the Department of the Interior for leasing and surface management in accordance with the Mineral Leasing Act, Federal Land Policy and Management Act, and other applicable statutes.

• Authorize the transfer of NOSR-3 (Colorado) to the Department of the Interior for leasing and surface management in accordance with the Mineral Leasing Act, Federal Land Policy and Management Act, and other applicable statutes, subject to a prior determination of the appropriate allocation of responsibility for environmental remediation and restoration, if any exists. Pending such determination, DOE would retain and continue to operate NOSR-3 under the Naval Petroleum Reserve law. Following such determination, DOE would continue to operate the developed tracts of NOSR-3 in accordance with the Naval Petroleum Reserves law until such tracts are leased.

• Authorize DOE, upon abandonment of production of NPR-3 (Teapot Dome), to sell or otherwise dispose of the United States' interest in NPR-3 in a manner that will maximize its value.

Several conforming amendments to existing laws would also be necessary.

This completes my formal statement, Mr. Chairman. I will be pleased to answer any questions you or Subcommittee Members may have.

¹ It should be noted that Gustavson prepared its assessments based on natural gas prices at the time the analyses were conducted, i.e., as of October 1, 1996. At that point, natural gas prices were relatively low, around $1.50 per thousand cubic feet. Since the Gustavson analysis was completed, natural gas prices have risen considerably, to well over $2.00 per thousand cubic feet, although recently they have dropped somewhat. Accordingly, if Gustavson's analyses were adjusted to reflect the higher gas prices, the value of each option would also be higher.