A Royalty Pain For The Big Oil Companies

Landowners allege the industry paid for their crude at an artificially low rate

Garry Mauro is the biggest oil baron in the Lone Star state. As commissioner of the Texas General Land Office, he presides over a 20 million acre empire of state-owned property that gushed $45 million in oil royalties last year.

But in 1995, Mauro concluded that the companies buying the vast majority of that oil were shortchanging him. By basing royalty payments on artificially low "market" prices, the companies were cheating Texas out of tens of millions of dollars, Mauro decided. So he sued for breach of contract. "When I run for office, the first thing they look at is how have I been managing the public lands. If I'm not getting the right price for oil, I'm dead meat," says Mauro, who is expected to run for governor next year.

BLACK EYE. Mauro is not the only one who feels cheated. A growing number of public and private landowners are making similar claims and pressuring the oil industry to make good on years of alleged underpayments--a development that could cost the industry billions of dollars and give it a public-relations black eye. "They were just ripping off the American people," says U.S. Representative Carolyn B. Maloney (D-N.Y.), the ranking minority member of the Government Reform Oversight Committee.

Over the past 10 months, the Interior Dept.'s Minerals Management Service has slapped Royal Dutch Shell, Oryx Energy, Unocal, and six other major oil companies with bills for nearly $400 million for royalty underpayments--and the agency plans to send out more. While MMS declines to estimate how much is owed the federal government for underpayments, the Washington watchdog group Project on Government Oversight estimates that it could be as much as $3 billion. All of the companies are fighting the bills, maintaining that there has been no underpayment. But Interior is girding for war. Sources inside and outside government say the agency has asked the Justice Dept. to investigate whether any of the companies with federal oil leases deliberately broke the law. Justice officials declined to comment.

EPIDEMIC. Following the lead of Texas, at least seven states are investigating whether they were ripped off by the oil companies, including Alabama, New Mexico, Oklahoma, and Wyoming. Meanwhile, Colorado, Montana, and other states are checking into whether artificially low-priced oil purchases helped some members of the industry escape taxes. To top it all off, private landowners have filed at least seven class actions. "In the last two years, the underpayment issue has grown to epidemic proportions," says James L. Stafford, president of the National Association of Royalty Owners in Ada, Okla.

All of these groups have basically the same complaint: that the "posted price" used to determine payments to landowners is generally 3% to 10% below market value. In fact, in the Texas case, attorneys have evidence indicating that shortly after purchase, the subsidiary of the company that buys the oil frequently turns around and sells it at a hefty markup, says H. Lee Godfrey, a Houston attorney. To put an end to this practice, the MMS in June proposed a new system that will require royalty payments on federal lands to be based on the price of oil on the New York Mercantile Exchange (NYMEX)--a change that could boost the industry's long-term costs.

The current wave of oil royalty litigation was prompted, in large part, by eye-popping judgments against the industry. In 1992, for example, the state of California received a settlement of $350 million from seven large oil companies after a two-decade struggle. And in 1994, Alaska recovered $3.7 billion. Before these successes, many smaller landowners had been fearful of the cost of litigating a royalty case, which involves exhuming old documents and recalculating thousands of royalty payments. But now, new classes of litigants are out for blood. "I honestly believe that the oil companies' liability is just starting," says Danielle Brian, executive director of the Project on Government Oversight.

RIPOSTE. The industry is fighting back hard. "We believe that the royalty payments have been appropriate and that the issues will be resolved appropriately," says Unocal spokesman David Garcia in El Segundo, Calif. The big oil companies declined to discuss the issue any further, citing current litigation.

The industry has at least one strong legal weapon on its side: Statutes of limitations will bar the vast majority of claims dating to before the 1990s. As a result, says John D. Hervey, oil industry analyst for Donaldson, Lufkin & Jenrette Securities Corp., companies will escape a major hit. "At the end of the day, I would assume they are going to have some liability. But even if it is a few billion dollars, that is not a major amount spread across the entire industry--especially since I think the sum total will be a lower number."

There are signs that some players may be anxious to put this problem to rest. In May, Mobil Oil Corp. announced a global settlement with private royalty owners for $15 million--though attorneys for plaintiffs not involved in the talks have said the deal lets Mobil off too easily and are threatening to undo it. Chevron Corp., meanwhile, recently reached a preliminary settlement with the state of Texas in which it agreed to pay $17.5 million and peg future royalty payments to NYMEX prices. That's good news for Mauro's next election effort and a big step for Big Oil in putting this mess behind it.

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