The federal government is trying a novel approach to collect royalties from oil and natural gas companies that drill wells on federal lands.

Under the royalty-in-kind program launched last year, energy companies can simply hand over a portion of the oil or gas produced to the U.S. Department of Interior. Currently, producers estimate the value of the oil and gas they've pumped and then pay royalties - a system that has exposed some of them to lawsuits charging they've undervalued their royalty payments.

The department sells the commodity to intermediate buyers. Then it splits the proceeds with the producing states when production is located onshore or in state waters, typically 3 miles from the shore. In most states, the royalty money goes toward school districts and local governments.

Royalties from off-shore production beyond state waters go toward land and water conservation funds, other federal funds and the U.S. treasury.

The royalty-in-kind program has been in place for offshore oil producers in the Gulf Coast. In the next few years, Colorado producers could benefit from it as well.

That's because the Department of the Interior is considering launching the program here, provided the state government agrees, said Gregory Smith, director of the program at Minerals Management Service.

The MMS, headquartered in the Federal Center in Lakewood, is the arm of the department that collects royalties.

"The program allows us to bring the cost (of collecting royalties) down. The need for auditing virtually goes away," Smith said. "We also can close the books in six months rather than several years."

Smith said that natural gas prices received by the Rocky Mountain producers have grown closer to other states in recent years due to the construction of natural gas pipelines.

That could facilitate the royalty-in-kind program here, since the federal government could negotiate with pipeline companies the marketing and delivery of its portion of natural gas to buyers.

"There is a much greater chance of transporting the gas out of the Rockies to other markets," Smith said. "It means, perhaps, there is more opportunity for the royalty-in-kind program here."

But Smith reiterated a feasibility study would have to be conducted before launching the program in Colorado.

The royalty-in-kind program, which was tried on an experimental basis from 1996 through 2003, was formalized last year. It is mostly used in the Gulf Coast states for offshore oil producers. In 2004, the program yielded $2.68 billion, $18 million more than if the royalties were collected in cash.

And the cost incurred was 20 percent to 32 percent less compared with the royalty-in-cash program.

In fact, 150 million barrels of oil collected through the program was used to fill up the Strategic Petroleum Reserve in recent years.

From January through May, Colorado received $42.06 million in royalties from the federal government, up from $34.68 million in the same period last year. All the royalties were collected in cash from the oil and natural gas producers.

How companies pay

* In the royalty-in-kind program, the federal government collects a portion of the physical commodity, such as oil or natural gas produced on federal lands, and sells it to intermediate buyers.

* Currently, the federal government collects royalties only in cash from oil and natural gas companies in Colorado that operate producing wells on federal lands.