TO: THOMAS BROZOVICH
FR: JENNIFER A. SMITH
ASSISTANT CHIEF COUNSEL
FOR ECONOMIC REGULATION
RE: ROYALTY-IN-KIND DETERMINATION OF NEED
DATE: MARCH 11, 1999
Minerals Management Services (MMS) requested the Office of Advocacy’s assistance in obtaining input on MMS’s Determination of Need for the Royalties in Kind (RIK) program. Specifically, MMS was interested in knowing the positions of the Small Business Administration and the Office of Advocacy on whether the RIK program is still needed and should be continued, as well as whether the program "dovetails" with the SBA’s overall mission and small/minority business development goals.
The Office of Advocacy is not authorized to speak on behalf of the Small Business Administration. We have, however, forwarded your comments to the appropriate offices in SBA for their comments directly to you.
After reviewing the information provided, and speaking to the members of the industry, Advocacy asserts that the continuation of the RIK program is necessary to preserve a competitive marketplace for the refining industry and to maintain reasonable gasoline prices for the national economy. The basis for the Office of Advocacy’s conclusion is provided below.
Background
The Minerals Leasing Act of 1920 allows the Department of Interior to take Federal royalty oil in kind, in lieu of royalty payment, and sell it to "eligible refiners" for use in their refineries. MMS uses the in-kind approach to maintain a robust oil refinery industry consisting of large and small facilities.
Periodically, MMS must assess the status of the crude oil marketplace and whether small refiners need "royalty-in-kind" stocks to replace what they cannot effectively compete for in the open market place. Because the market for crude oil is controlled through short and long-term production agreements between producers and refiners, MMS must inquire into the status of small refiner purchasing agreements and their success at obtaining raw refining materials. More specifically, MMS must assess whether or not the current market climate mandates "royalty-in-kind" leases to protect small refiners.
The Office of Advocacy’s Review
As part of the Office of Advocacy’s review, the Office of Economic Research reviewed the materials provided by MMS. The Office of Advocacy also obtained industry feedback on the issue through conference calls, an industry roundtable, and inquiries to minority groups.
Office of Economic Research’s Assessment
Dr. David Schnare, Senior Advisor on Regulatory Impacts for the Office of Economic Research for the Office of Advocacy, reviewed the materials provided and other economic data. Dr. Schnare found that it was difficult to evaluate the program and ascertain its need without both current and time-series data. However, from the documents and independent data that he did review, Dr. Schnare was able to conclude that:
Small refineries appear to be able to provide cost-competitive products during economic prosperity. … Control of access to crude oil through long-term contracts could significantly harm competition within the market. Forced competition through the royalty-in-kind program would destroy the potential for monopoly prices arising from large refinery dominance. …"
From Dr. Schnare’s assessment, the Office of Advocacy concludes that the continuation of the program is necessary to maintain a competitive marketplace and maintain reasonable oil prices for the industry and the national economy.
Industry Feedback
According to the industry, the program provides small businesses with an opportunity to obtain crude oil at a reasonable rate. The companies are able to use oil for swap purposes and other economic benefits that help them compete in the marketplace. Moreover, the members of the industry that spoke with Advocacy asserted that since the RIK contracts are for a 3-year period, rather than the customary 45 to 90 day contracts offered by the majors oil companies, the RIK program offers small businesses a type of security. They further alleged that although the current supply may be inexpensive, acquisition of crude oil is far more difficult than it has been in the past and involves additional costs. The market is cyclical and, at times, volatile.
In addition, some of the refining companies stated that the decline in participation in the program cited in MMS materials is not due to a lack of interest on the part of the small refiners or the availability of crude from other sources. Rather, it is the result of past inefficiencies in the program. In the past, some small business dropped out of the program because of administrative problems with the pricing structure. For example, small businesses where not sure of the price of the crude oil or MMS would impose an additional price retroactively. Once the refiners left the program, they were not allowed to reenter.
Although the refiners acknowledge that this problem no longer exists since MMS implemented a negotiated price, MMS has not opened the program to allow for reentry. Under the new policies, the some members of the industry indicated that additional companies would participate in the program.
The Office of Advocacy is particularly concerned by the fact that small businesses are interested in entering the program but are unable to do so because MMS has not reopened the process in a number of years. The Office of Advocacy implores MMS to address this concern in the near future.
Minorities and the RIK Program
As part of the Office of Advocacy’s review of the RIK program, Advocacy also contacted minority companies and trade associations. The minority companies and trade associations that the Office of Advocacy spoke with had little or no knowledge of the RIK program. They did, however, indicate that they might be interested in participating in the RIK program.
The Office of Advocacy questions whether MMS has performed sufficient outreach to educate disadvantage businesses about the availability and benefits of the program. Without sufficient outreach, disadvantaged businesses may not have the knowledge necessary to be able to participate in the program. The lack of knowledge and participation may hinder a socially and economically disadvantaged business’s ability to participate more fully and successfully in the mainstream national economy. If such hindrance is present, the Office of Advocacy questions whether the program would meet the goals of the SBA’s Office of Minority Enterprise Development.
Lack of Sufficient Information in Request for Determination of Need
As noted by Advocacy’s Office of Economic Research, additional information is necessary if MMS wants a more definitive answer about the economic impact of the program on small refiners. The Office of Advocacy knows that MMS would have willingly answered the questions about the lack of clarity and information in the information provided. Advocacy, however, purposely did not seek additional information from MMS. Instead, Advocacy chose to view this assignment from the standpoint of the average small businessperson that may or may not have the resources necessary to obtain additional information.
From a public policy standpoint, the Office of Advocacy asserts that notices that are intended for public should provide enough information to allow the government and the public to determine the effect that an agency action may have, from an economic and policy standpoint, as well as the tangible benefits of the program. In this particular instance, MMS is soliciting comments to determine whether the RIK program is needed. There may be small refining businesses that do not have knowledge of the program but may be interested in participating in the program. Since there is no economic information, those businesses may not have been able to ascertain whether or not it would be beneficial to participate in the program.
Conclusion
The Office of Advocacy believes that the RIK program may be beneficial to small businesses and assert that the program should be continued. However, the Office of Advocacy would like to see additional information on the tangible benefits of the program before rendering a final decision on whether the program falls within the goals and objectives the Office of Advocacy. The Office of Advocacy would also like to see improvements in the program to address the concerns raised by small businesses and increased outreach to the minority refiners.
If you have any questions, please feel free to contact me at 202-205-6943. Thank you for the opportunity to comment on the RIK program.