The obscure federal agency that oversees the offshore drilling industry -- second only to the Internal Revenue Service in generating government revenue -- has a deeply troubled record of collecting royalties from the $1 trillion-a-year petroleum industry, records show.

That agency, the Minerals Management Service, has two main missions: To enforce drilling safety rules and collect billions in royalties. Since the April 20 BP Gulf rig blowout, scrutiny has focused almost exclusively on MMS' safety standards.

Yet critics -- including former MMS employees -- have long accused the agency of going light on the industry in collecting royalties. Government investigators have repeatedly chided the MMS for weak enforcement and loose standards in seeking the fees, potentially costing the government -- and taxpayers -- billions in unclaimed royalties.

In one notorious case, the MMS was literally found in bed with the petroleum industry: Two MMS employees were cited for having brief sexual relationships with oil company officials, according to a 2008 probe by the Interior Department's inspector general.

GIFTS, BOOZE, GOLF

The investigation also found that oil and gas executives had plied 19 employees in an MMS royalty office with gifts, booze, and golf and ski trips. ``Our investigation revealed an organizational culture lacking acceptance of government ethical standards,'' the inspector general concluded.

Even as drilling exploration increased throughout the Gulf from 2000 to 2006, the MMS reduced the number of workers in its royalty compliance office by 75 positions. Spending on royalty enforcement in the Gulf fell nearly $3 million from 2003 to 2006. And, records show, the agency is increasingly relying on information provided by the companies in collecting royalties.

CONFLICTING ROLES

These trends evolved against the backdrop of the agency's conflicting roles as regulator, bill collector and promoter of drilling exploration. Critics say the scales have tipped heavily one way. 

Tyson Slocum, director of the energy program for the left-leaning nonprofit watchdog group Public Citizen, said the gifts scandal simply added a sleaze factor to the legendary kowtowing culture of MMS.

``We knew the MMS was a corrupt agency,'' said Slocum. ``It's in the popular culture that this agency is a joke.''

Yet it took the environmental catastrophe to do what scathing government investigations, years of bipartisan criticism, the sex-and-gifts scandal and a $10 billion bureaucratic bungle could not: force the dismantling of the MMS, ordered last week in Washington.

MMS officials did not respond to interview requests last week.

HONOR SYSTEM

The MMS, an office within the Interior Department, was created ostensibly to help solve problems collecting royalties, after a critical 1982 study deemed Interior's efforts a ``failure.''

``The oil and gas industry is not paying the royalties it rightly owes,'' the 1982 report found. ``The industry is essentially on the honor system.'' 

Almost 30 years later, with the MMS collecting more than $12 billion a year in royalties from gas and oil companies, little has changed.

MMS depends largely on the self-reporting of oil and gas companies to determine how much they owe in royalties -- a system the Interior Department's former inspector general, Earl Devaney, described as ``basically an honor system'' in congressional testimony in 2007.

Just two months ago, the Government Accountability Office, the investigative arm of Congress, found that MMS continued to rely on dated and imprecise methods to gauge the amount of oil and gas produced on federal lands and leases. The GAO said the MMS was hindered by ``limited oversight, gaps in staff skills, and incomplete tools.''

`2 SETS OF BOOKS'

Similar complaints arose in the 1990s, when the Project On Government Oversight, a nonprofit watchdog group, filed lawsuits accusing oil companies of deliberately misleading the government about their oil and gas sale prices, thus minimizing their royalties. The Justice Department later joined many of those suits, which resulted in almost $500 million in settlement payments from petroleum companies.

``We had whistleblowers who were saying that the industry was essentially gaming MMS,'' said Danielle Brian, POGO's executive director. ``Essentially, they had two sets of books.''

The MMS commonly negotiates settlements with petroleum companies over disputed royalties -- but the process is often shrouded in secrecy. A 1996 inspector general report found that MMS officials kept no documents on nine out of 10 royalty settlements, to prevent disclosure under the Freedom of Information Act. In one case, the MMS could provide no records to explain why the agency reduced its estimate of a company's royalty debt by $360 million.

The embarrassments continued in 1998 and 1999, when the MMS neglected to include price limitations to trigger royalty payouts on leases for the deepest parts of the Gulf of Mexico -- in effect, allowing many companies to pump out oil and gas for free. The mistake went unnoticed until 2006.

ANGER IN CONGRESS

The error sparked outrage in Congress and yet another probe by Devaney, the inspector general. He later called the oversight a ``jaw-dropping example of bureaucratic bungling'' and said it could cost the government as much as $10 billion.

The screw-up was rendered moot last year, when a federal appeals court said the MMS could not impose price triggers on any deepwater Gulf leases approved between 1996 and 2000 -- thanks to a law passed by Congress curbing royalties to encourage more Gulf drilling. The court ruling could cost the government an additional $19 billion to $60 billion in future royalties, according to estimates.

Amid these problems, the agency took a less stringent approach to royalty collection, relying less on comprehensive audits to determine if companies were paying their fair share. MMS officials said they instead used less costly ``compliance reviews'' -- relying mainly on information provided by the companies -- to speed up its process of monitoring royalty payments, which can take years.

With fewer people, the agency was less equipped to investigate discrepancies between the oil and gas totals companies reported in royalty payments and measurements the agency collected from other sources, the inspector general found.

HELPING THEIR FRIENDS

``The priority was not on generating revenue,'' Slocum said. ``There were people in the administration and Congress who wanted to see their friends get taken care of.''

Some MMS auditors said the agency went easy on the industry. In 2004 and 2005, three auditors filed lawsuits accusing oil companies of deliberately under-paying their royalties -- and accusing MMS managers of ignoring their findings. The workers filed suit under a federal law that allows citizens to collect if they discover fraud against government.

``I would say that MMS has done a very inadequate job of pursuing any type of fraud. I believe its record is basically nonexistent on that,'' former MMS auditor Bobby Maxwell said in a 2005 deposition.

Three years ago, a Colorado jury found in Maxwell's favor with a $7.6 million verdict against Anadarko Petroleum. But the judge threw out the verdict, and Maxwell is fighting to have it reinstated.

The Interior Department's inspector general concluded that many of the problems at MMS stemmed from the agency's ``systemic dilemma'' of ``conflicting roles.''

SPLITTING THE AGENCY

Addressing this conflict in the wake of the Gulf of Mexico drilling disaster, the Obama administration last week announced plans to split the MMS into three parts -- with separate offices devoted to royalty collection, safety and environmental regulation, and offshore lease management.

Some watchdogs say the reform doesn't go far enough. By leaving existing leadership in place, the changes amount to ``rearranging the deck chairs on the Deepwater Horizon,'' said Jeff Ruch, executive director of Public Employees for Environmental Responsibility.

Interior Secretary Ken Salazar conceded in testimony before the Senate last week that MMS has been too lax in enforcing safety rules, and asked Congress to boost the budget for safety inspectors by $20 million.

``The days of [oil companies] treating the federal domain as essentially part of a candy store are over,'' Salazar told the Senate's Energy and Natural Resources Committee.

Salazar said his staff is working to erase the stain of cronyism from the MMS, and he's asked federal prosecutors to take a look.

He also wants to end the ``revolving door'' ethos that permeated the MMS, where top officials, including the last MMS director under President Bush, went to work for the industry. 

But Salazar is going to have to do more to impress Sen. Bill Nelson, D-Fla., one of the agency's loudest critics.

``Secretary Salazar said we have a few bad apples,'' said Susie Perez Quinn, Nelson's deputy legislative director. ``We think it's more like a whole orchard.''

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