CHAPTER 1 FEDERAL GAS VALUATION REGULATIONS

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 1
FEDERAL GAS VALUATION REGULATIONS
FINAL REPORT FEDERAL GAS VALUATION NEGOTIATED RULEMAKING COMMITTEE
DEPARTMENT OF THE INTERIOR MINERALS MANAGEMENT SERVICE

MARCH 1995

Table of Contents

SYNOPSIS Page No.

EXECUTIVE SUMMARY

AUTHORITY

FORMATION AND OPERATION

SCOPE AND OBJECTIVES

PRINCIPLES

RECOMMENDATIONS

COMMITTEE REPORT

I. COMMITTEE BACKGROUND

AUTHORITY

FORMATION AND OPERATIONS

SCOPE AND OBJECTIVES

PRINCIPLES

II. DISCUSSION OF RECOMMENDATIONS

A. VALUATION OF GAS SOLD UNDER ARM'S-LENGTH SALES CONTRACTS AND NON-ARM'S-LENGTH SALES CONTRACTS IN AREAS WITH AN ACTIVE SPOT MARKET

1. Background

2. Alternative Proposals Considered

a. Secretarial Established Value

b. Unrestricted Lessee-Election

c. Case-by-Case Approval

d. Gross Proceeds/Weighted Average Pool Pricing

3. Discussion of Final Recommendation

a. Background of Index Pricing

b. Final Recommendation

Criteria for Index-Based Method

Index Pricing Point

Location Differential

Choice of Index Publication

Safety Net Calculation

Representative Sample

Zone Determination

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B. VALUATION OF GAS SOLD UNDER NON-ARM'S-LENGTH SALES CONTRACTS IN AREAS WITH NO ACTIVE SPOT MARKET

1. Background

2. Alternative Proposals Discussed

3. Discussion of Final Recommendation

C. VALUATION OF NATURAL GAS LIQUIDS

1. Background

2. Explanation

3. Negotiation

D. GAS PRODUCED FROM UNIT AND COMMUNITIZATION AGREEMENTS

1. Background

2. Alternative Proposals Discussed

a. SB-X (Senate Bill 168 example)

b. Modified Takes

c. Entitlements

d. Entitlements with Marketing Requirement/Option

e. Exception to Entitlements

3. Final Recommendation

E. TRANSPORTATION VS. GATHERING

1. Background

2. Discussion of Final Recommendation

F. COMPRESSION

1. Background

2. Explanation

3. Negotiation

G. TRANSPORTATION AND PROCESSING ALLOWANCE FORMS

H. DUAL ACCOUNTING

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III. ATTACHMENTS

1. June 27, 1994, Federal Register Notice

2. June 2, 1994, Charter Signed by the Secretary of the Interior

3. Negotiated Rulemaking Committee Membership List

4. List of Acronyms

5. List of Definitions

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COMMITTEE REPORT

EXECUTIVE SUMMARY

AUTHORITY

The Federal Gas Valuation Negotiated Rulemaking Committee (committee) was established under the authority of the Federal Advisory Committee Act (FACA) (5 U.S.C. App.) (Pub.L. 92-463) and the Administrative Procedures Act (APA) (5 U.S.C. 553).

FORMATION AND OPERATION

In 1993, in response to Vice President Gore's National Performance Review (NPR), the Royalty Management Program (RMP) initiated a Reinvention Laboratory Team to examine ways to streamline the royalty management process. One of the recommendations of the NPR Team was to improve the gas valuation benchmark system. The NPR Team recommended conducting a pilot to evaluate the use of spot prices as the second benchmark. In commenting on the recommendations of the NPR Team, the Royalty Management Advisory Committee (RMAC) recommended that the current benchmark system be evaluated by a study group including representatives of Minerals Management Service's (MMS) constituents. The RMAC also recommended that the study be limited to gas produced from Federal leases.

In December 1993, MMS formed an informal group to study the benchmark system and, as a related issue, the valuation of gas produced from approved Federal unit and communitization agreements (Agreements). The scope of the study was later expanded to include valuation of Federal gas production under arm's-length contracts.

Upon review of the requirements of FACA and APA, the Department of the Interior (Department) determined that the study group should operate as a negotiated rulemaking committee. A June 27, 1994, Federal Register Notice (59 F.R. 32943) (Attachment 1), published by MMS, transformed the group into the Federal Gas Valuation Negotiated Rulemaking Committee. Attachment 2 contains the June 2, 1994, charter of the committee signed by the Secretary of the Interior.

Members of the committee included representative of the American Petroleum Institute (API), the Council of Petroleum Accountants Societies (COPAS), the Rocky Mountain Oil and Gas Association (RMOGA), the Independent Petroleum Association of America (IPAA)/Independent Petroleum Association of Mountain States (IPAMS), the Natural Gas Supply Association (NGSA), an independent marketer, representatives of large independent producers, and personnel from the States of Utah, North Dakota, Montana, and New Mexico representing the State and Tribal Royalty Audit Committee (STRAC).

The informal study group and later the committee agreed to operate based on consensus decision making. Consensus was determined by members indicating their vote in one of three ways: thumbs-"up," "sideways," or "down." A "sideways" thumb meant a qualified

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"yes" vote and in order to have consensus all thumbs had to be up or sideways. The committee also agreed that its final report and the resulting proposed rule do not prohibit any committee member or his/her constituents from commenting on the proposed rule or challenging the final rule, or any order issued pursuant to the rule.

SCOPE AND OBJECTIVES

The Secretary of the Interior chartered the committee to advise MMS on a rulemaking to address: 1) the valuation of gas produced from approved Federal unit and communitization agreements (Agreements) (particularly when lessees take less than or none of their entitled share), and 2) the benchmark valuation system for valuing gas sold under non-arm's-length contracts. The scope of the committee was limited to examining values for gas (processed and unprocessed) produced from Federal leases.

The original committee charter established specific objectives for improving the process of valuing natural gas for royalty purposes. These objectives were to:

• Develop a method that allows lessees to use information to which they have access and reduces uncertainty on royalty values acceptable to MMS.

• Examine the suitability of using indices (that is, spot prices or other published prices) to value gas where sales do not occur at arm's-length or where there are no sales at all. Related issues such as transportation were to be included in this discussion.

• Establish timely and definitive criteria for lessees and auditors to use in valuing gas, where lessees sell under non-arm's-length contracts or where lessees sell less than or none of their entitled share.

The committee identified additional objectives which included simplicity, administrative cost savings, and revenue neutrality for both lessees and lessors to the extent it could be determined.

PRINCIPLES

The committee charter established certain principles of royalty accounting, required by mineral statutes and lease terms, that form the basis for evaluating options to replace the current rules:

Volume — Royalties must be paid each month on the volume of production allocated to or produced from the Federal lease under the Agreement terms.

Royalty Rate — Royalties must be paid in accordance with the royalty rate specified in each lease unless specified otherwise under the terms of the Agreement.

Value of Production — Value should be determined at the time of production. Value should be based on the fair market value at the lease.

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Payment Responsibility — Federal lessees or their working interest owners are ultimately responsible for paying royalties, but other entities can be assigned the royalty payment responsibility.

RECOMMENDATIONS

As a result of committee negotiations and the above-noted objectives and principles, the committee reached consensus on the following recommendations for valuing: 1) gas sold under arm's-length and non-arm's-length contracts, 2) natural gas liquids, and 3) gas produced from Agreements.

These recommendations apply only to the Btu contributing component of the gas produced from Federal oil and gas leases. Any royalty bearing but not Btu contributing naturally occurring gas comprising all or a significant part of a gas stream from a Federal oil and gas lease will be valued as if it were produced in a zone not eligible for index-based valuation. Where gas streams consist of both Btu contributing and noncontributing components, the Btu contributing portion may be valued according to the recommendations of the committee. The following is a summary of these and other recommendations agreed to by the committee.

• Value of gas sold under arm's-length contracts must be based on gross proceeds. However, in areas where there is an active spot market and valid published indices, if certain criteria are met, value may (at the lessee's option) be based on an index-based method unless the sale is dedicated as defined by the committee. For gross proceeds-based valuation, value will not be based on the higher of gross proceeds or index.

• Value of gas sold under non-arm's-length contracts must be based on an index-based method in areas where there is an active spot market and valid published indices, unless the lessee notifies the MMS of its intent to use its affiliate's arm's-length gross proceeds. Where there are no valid published indices and no active spot market, value must be based on the existing benchmark system or whatever replaces the benchmark system..

• Value of natural gas liquids (NGL) derived from non-dedicated gas produced in areas where there is an active spot market and valid published indices may be based on an index or a residue gas price, as applicable, applied to a wellhead MMBtu. However, lessees reporting NGL on gross proceeds must convert gallons to MMBtu's.

• The committee concurred with MMS' proposal that for gas produced from Agreements which contain only Federal leases with the same royalty rate and funds distribution, and from leases not in an Agreement (stand alone leases), volume and value must be...