AN OVERVIEW OF THE FEDERAL MINERAL ROYALTY AUDIT PROCESS - INDIAN TRIBAL AUDIT PROCESS

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management Book 1
(Feb 2004)
CHAPTER 6B
AN OVERVIEW OF THE FEDERAL MINERAL ROYALTY AUDIT PROCESS - INDIAN TRIBAL AUDIT PROCESS
Perry Shirley
The Navajo Nation
Division of Natural Resources - Minerals Department
Window Rock, Arizona
TABLE OF CONTENTS

I. Introduction

II. Indian Gas Valuation under the March 1, 1988 Regulations

III. Indian Gas Valuation under the January 1, 2000 Regulations

A. Index-Based Valuation

B. Alternative Methodology for Dual Accounting

C. Safety Net Calculations for Index Zone Leases

D. Non-Index-Based Valuation

E. Actual Dual Accounting Calculation Method

F. Transportation Allowance

G. Processing Allowance

H. Processing Costs for Dual Accounting Purposes

IV. Conclusion

"Indian Tribal Mineral Lease Audit Process"

I. Introduction

The Navajo Nation is one of eight Tribes that have entered into Cooperative Agreements with the U.S. Department of the Interior, Minerals Management Service (MMS) to conduct audits of their respective tribal mineral leases. The authority for the Cooperative Agreements is provided under Section 202 of the Federal Oil and Gas Royalty Management Act of 1982, as modified by the Enrolled 1992 Appropriation Bill, H.R. 2686-12 (FOGRMA). Specifically, Section 202 addresses Cooperative Agreements for Indian tribes, whereas Section 205 addresses Delegation to States. Although FOGRMA was signed into law on January 12, 1983, the states and tribes began exercising their audit authorities under FOGRMA in different years. The Navajo Nation has been performing compliance reviews of its mineral leases since 1984.

There are two types of Indian leases, those that belong to individual Indian tribal members, which are generally referred to as "allotted leases", and those leases that belong to an Indian tribe. For Indian leases, the Individual "allottee" or Indian tribe is the lessor and is a signatory party to the lease contract. The Secretary of the Interior (Secretary) is obligated to act as a fiduciary in the administration of Indian oil and gas leases. ¹

Whereas FOGRMA provides the authority for the Indian tribes to perform audits of its respective tribal mineral leases, the audit responsibility for "allotted leases" remains with the MMS. Because the Navajo Nation's audit authority is limited to audits of Navajo tribal mineral leases, the compliance experiences related herein are those of the Navajo Nation's Minerals Audit Program. Furthermore, the ideas, opinions and viewpoints represented in this paper are those of the author and not necessarily the official views of the Navajo Nation or the MMS.

The purpose of this paper is to present an overview of several areas that are unique to Indian leases in the audit process for Indian gas production. While the overall Indian audit process and procedures are quite similar to those employed by State audit entities, Indian leases have unique lease term provisions in addition to separate regulations that govern the valuation of oil and gas production. As such, there are areas where different audit procedures are followed by Indian tribal audit entities and this paper will discuss a few of those areas. In a related paper, the Federal royalty audit process that is generally used by States and Tribes alike is presented. This addendum paper will attempt to distinguish areas of importance in compliance with determining valuation under Indian tribal leases, which in turn, may facilitate a better understanding of future compliance reviews. This paper is not intended to provide royalty valuation guidance, specific audit guidance, nor is it intended to promote the position of the Navajo Nation or any other Indian tribe regarding compliance audits.

The Indian crude oil valuation rule at 30 CFR § Part 206, have remained largely unchanged since March 1, 1988. However, MMS is proposing further changes that would modify the regulations that establish value for oil produced from Indian leases. In addition, the proposed changes may create a new form for collecting value and location differential data. Current oil valuation regulations rely on posted prices and prices under arms-length sales to value oil that is not sold at arms-length. However, over the past years, it has been asserted that posted prices have not been an adequate representation of market value. The proposed changes would decrease reliance on oil posted prices and place reliance on crude oil spot prices, while still taking into consideration major portion price calculations and gross proceeds as comparison values. At this time, MMS is currently assessing the responses received from the latest comment period on the proposed changes. Since July 1995, the Navajo Nation has been taking a majority of its crude oil production in-kind to avoid sole reliance on oil posted prices with no other consideration. Because of this fact and the ongoing Indian crude oil valuation rulemaking process, this paper is limited to an overview of the audit areas related to Indian gas production.

II. Indian Gas Valuation under the March 1, 1988 Regulations

Prior to the enactment of the Indian Mineral Development Act of 1982, ² which permitted tribes to negotiate their own mineral leasing and development agreements with third parties, most Indian minerals were leased under a BIA Standard Lease Form 157, which contained standard terms and provisions drafted by the Department of the Interior under authority of the Indian Mineral Leasing Act of 1938. ³ In addition to specifying the royalty rate, paragraph 3(c) of such leases provides that:

"ÝV¨alue... may, in the discretion of the Secretary, be calculated on the basis of the highest price paid or offered...at the time of production...for the major portion of...gas...produced and sold from the field where the leased lands are situated... The actual amount realized by the lessee from the sale of said products may, in the discretion of the Secretary, be deemed mere evidence or conclusive evidence of such value... It is understood that in determining the value for royalty purposes of products...derived from the treatment of gas, a reasonable allowance for the cost of manufacture shall be made, such allowance to be two-thirds of the value of the marketable product unless otherwise determined by the Secretary of the Interior...and...royalty will be computed on the value of gas or casinghead gas, or on the products thereof...whichever is greater. (emphasis added).

Indian leases containing these unique valuation provisions, specifically valuation methods requiring that royalties be calculated using major portion ⁴ and dual accounting ⁵ (or accounting for comparison) criteria have been problematic, in terms of lessee compliance and from an royalty management standpoint. The primary reason given by many companies for lack of compliance with these lease provisions is attributed to difficulties in obtaining information and documents necessary to comply with major portion and dual accounting lease requirements. Compliance with major portion requires royalty lessees to have access to other company sales data to calculate the major portion price. Such sales data is considered confidential and subject to certain disclosure protection laws.

The March 1, 1988 gas regulations at...