Report 2010-125 Summary - August 2011

State Lands Commission

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Because It Has Not Managed Public Lands Effectively, the State Has Lost Millions in Revenue for the General Fund

HIGHLIGHTS

Our review of the State Lands Commission's (commission) management of leases disclosed that the commission:

RESULTS IN BRIEF

The State Lands Commission (commission) is responsible for managing the lands that the State acquired from the federal government at statehood, including the beds of navigable rivers and lakes, submerged land along the State's coast, and school lands granted to the State for the benefit of public education. The commission's management of these lands provides the State with revenues from leases and from the State's share of net profits derived from activities conducted on state lands. However, we found that the commission has not always managed its more than 4,000 leases in the State's best interest. As a result, it has missed opportunities to generate millions of dollars in revenues for the State's General Fund—estimated to be as much as $8.2 million for just some of the leases in the sample of 35 we reviewed.

Specifically, the commission is not effective or consistent in seeking payment from lessees whose rent is past due—known as delinquent lessees—in part because it does not have policies and procedures specifying the steps it needs to take to appropriately manage these leases. Furthermore, it does not consistently take any other actions, such as evicting delinquent lessees, to ensure that it is protecting the State's interest in its properties. In fact, we found that 130 of the commission's nearly 1,000 revenue-generating leases were past due on rent and that the commission has allowed some of the delinquent lessees whose leases we reviewed to remain on state land for up to 22 years without paying rent. For example, Crockett Marine Services, Incorporated (Crockett) has not paid any rent since 1989; however, the commission has not actively sought to remove or otherwise penalize Crockett at any time since it stopped paying its rent. In fact, it was only after we inquired about this lease that the commission found that Crockett is subleasing the land to another party from whom Crockett is collecting rent. We estimate that the commission may have lost as much as $662,000 for this one lease alone, with estimated losses totaling $1.6 million for a sample of 10 delinquent leases we reviewed, including the Crockett lease.

According to the chief of the commission's Administrative and Information Services Division, part of the reason that the commission does not consistently take action against delinquent lessees is because actions such as eviction require litigation, which is costly and staff intensive. Nonetheless, although state law prohibits the commission from taking formal legal action against a lessee unless it retains the services of the Office of the Attorney General (attorney general), state law allows the commission to recover the costs of the legal action. Further, state law does not prohibit the commission from using a collection agency to collect past-due rent. Thus, we expected that the commission would have conducted a cost-benefit analysis to determine when it would be beneficial to either seek a court judgment through the attorney general or pursue the case in another manner, such as using a collection agency. However, according to its chief counsel, the commission has not conducted a formal analysis of this type. Therefore, we question how the commission determined that litigation was too costly to pursue.

Moreover, the commission has not always taken timely action to renew its expired leases, conduct rent reviews, or consistently appraise its properties. For example, about 140 of the commission's revenue-generating leases are currently expired and are in holdover—the term the commission uses when referring to leases that have not been extended or renewed. During the time their leases are in holdover, lessees continue to pay the amounts stipulated by their expired leases. As a result, the commission loses the rent it could have collected if it had promptly renegotiated the leases using a recent appraised value. Because of this, we estimate the commission lost up to $269,000 for 10 leases we reviewed that are currently in holdover. The commission has recently implemented procedures it believes will prevent leases from going into holdover. Although these new procedures appear reasonable, because the commission only recently implemented them, we were unable at the time of our audit fieldwork to determine whether they would be effective.

Rent reviews can result in modifications to the rental amounts the commission charges lessees—frequently resulting in increased rental amounts—but the commission has failed to promptly conduct rent reviews, causing it to lose $6.3 million1 in increased rent that it may have been able to collect on 18 of the 35 leases in our sample. Nearly all leases contain language that allows the commission to increase the rental amount by conducting a rent review on the fifth anniversary of the lease. However, the commission failed to perform timely rent reviews for these 18 leases, in part, according to the chief of the Land Management Division (land management), because of staffing shortages.

The commission also does not appraise its leased properties as frequently as the lease agreements allow, which generally is at least once every five years in preparation for a rent review. For example, we found that the commission appraised the value of the properties related to the sample of leases we reviewed an average of only three times over the period during which the commission could have performed a rent review, which ranged from five to 41 years, and it has not conducted an appraisal for several leases in more than 15 years. Because these properties increased in value over time, the commission missed opportunities to increase their related rent. Furthermore, when it did perform these periodic appraisals, it used methods that may have resulted in values that were lower than they might have been using other methods, again missing opportunities to increase the State's revenues. For example, the regulations that specify the rate that the commission should use to calculate rent for its pipeline leases were established in 1981. We estimate that, as a result of using this outdated rate, the commission may be losing up to $174,000 for a sample of seven pipeline leases we reviewed for each year it fails to update the rate. Additionally, the commission may be losing revenue because it has not performed an analysis to determine whether it is more profitable to receive royalties on oil extracted from state land in the form of cash or crude oil.

In order for the commission to meet its responsibilities, we expected to find that it uses a database that would allow it to manage its leases effectively, assisting the commission in performing timely rent reviews and lease renewals and in accurately invoicing lessees. Instead, we found that the data in the commission's Application Lease Information Database (ALID) are both inaccurate and incomplete, and staff do not use the database to track lease information. Further, we found that each division has developed its own method of tracking leases, but the information is not consistent among the divisions. As a result, the commission is not appropriately tracking the status of some of its leases. For example, the commission apparently lost track of one of its leases, and as a result failed to bill the lessee for 12 years while the lessee remained on state property.

The commission is also not effectively performing two other key functions: auditing the funds generated from its revenue-producing leases or granted lands and ensuring that lessees maintain current surety bonds and liability insurance. With respect to its auditing program, the commission has not developed a plan for monitoring its nearly 1,000 revenue-generating leases and, in particular, about 85 leases that are potentially the most profitable because they include leases that involve the extraction of oil and gas from state properties. In fact, the commission has completed only two audits since 2008, neither of which were for oil or gas leases. Thus, the commission is not ensuring that the State is receiving the appropriate amount of revenues from its revenue-generating leases.

Although the commission has undergone a series of staff reductions since 1990 and has made attempts to replace these lost positions, it has not taken sufficient steps to quantify its need for additional staff. In fact, the commission's land management and Mineral Resources Management divisions—the divisions with the most responsibility for managing its leases—have experienced staffing reductions of 50 percent and 32 percent, respectively. We found that although commission managers expressed a need for more staff to adequately perform critical duties such as rent reviews, they had not developed any analyses to determine an appropriate workload and the number of staff needed to address such a workload. In addition, the commission has not developed a succession plan to address its future workforce needs, exposing it to the further loss of knowledgeable staff and a continuation of the problems it currently has with effectively managing its leases.

RECOMMENDATIONS

To ensure that it manages delinquent leases in an effective and timely manner, the commission should do the following:

To ensure that as few leases as possible are in holdover, the commission should continue to implement its newly established holdover reduction procedures and periodically evaluate whether its new procedures are having the intended effect of reducing the number of leases in holdover.

To complete its rent reviews promptly and obtain a fair rental amount for its leases, the commission should conduct rent reviews on each fifth anniversary as specified in the lease agreements or consider including provisions in its leases that allow it to use other strategies, such as adjusting rents annually using an inflation indicator.

To ensure that it is charging rent based on the most current value of its properties, the commission should appraise its properties as frequently as the lease provisions allow—generally once every five years.

To ensure that it does not undervalue certain types of properties, the commission should do the following:

To improve its monitoring of leases, the commission should do the following:

To adequately monitor its revenue-generating oil and gas leases, the commission should do the following:

To better demonstrate its need for additional staff, the commission should conduct a workload analysis to identify a reasonable workload for its staff and use this analysis to quantify the need for additional staff.

To better address current and potential future staffing shortages, the commission should create a succession plan.

AGENCY COMMENTS

The commission agrees with many of our recommendations and states that it is implementing or is planning to implement most of them.

1 After we completed our fieldwork, the commission ultimately negotiated and the commissioners approved a new lease with Shell Oil Company on June 23, 2011, which is one of the leases included in our sample that resulted in our estimate of $6.3 million in lost revenues. As part of its negotiations, Shell Oil Company agreed to pay $2.5 million for the period from August 1999 to July 2011.