CHAPTER 1 LEGAL FOUNDATION FOR FEDERAL AND INDIAN ROYALTY VALUATION AND MANAGEMENT

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management
(Feb 2007)
CHAPTER 1
LEGAL FOUNDATION FOR FEDERAL AND INDIAN ROYALTY VALUATION AND MANAGEMENT
Peter J. Schaumberg ¹
Attorney
Beveridge & Diamond, P.C.
Washington, D.C.
Geoffrey Heath ¹
Assistant Solicitor, Division of Mineral Resources
Branch of Federal & Indian Royalties
Office of the Solicitor, Department of the Interior
Washington, D.C.

PETER J. SCHAUMBERG

Peter J. Schaumberg is Of Counsel in the Washington, D.C. office of Beveridge & Diamond, P.C. His practice focuses on mineral royalty, land use, oil and gas, and mining sector matters. Mr. Schaumberg also works on matters involving renewable energy resources, such as offshore wind energy development. Mr. Schaumberg began his career as an Honors Graduate at the IRS and quickly moved into the field of energy management and public lands. He spent 25 years at the U.S. Department of the Interior where he retired in 2006 as the Deputy Associate Solicitor for Mineral Resources, the senior career attorney responsible for federal onshore and offshore mineral development matters. During his tenure at the Department of the Interior, Mr. Schaumberg worked with its various sub-agencies, including the Minerals Management Service, the Bureau of Land Management, the Office of Surface Mining, the National Park Service, and the Bureau of Indian Affairs. He spent 25 years working on the royalty management regulations for the Minerals Management Service and is a highly recognized authority with respect to those regulations. Mr. Schaumberg took a lead role in the review and implementation of the federal Energy Policy Act of 2005 and was also responsible for review of offshore oil and gas development. Mr. Schaumberg received the Presidential Rank Senior Executive Service Meritorious Service Award and Secretary of the Interior Meritorious Service Award for his outstanding work. Mr. Schaumberg is a former Trustee of the Rocky Mountain Mineral Law Foundation and is a frequent contributor to its programs and publications. He earned a B.A., cum laude, at Tulane University in 1972 and a J.D., with Honors, from George Washington University National Law Center in 1975. He is a Member of the American Bar Association and is admitted to practice in the District of Columbia and before the U.S. Supreme Court.

GEOFFREY HEATH

Geoffrey Heath is the Assistant Solicitor for Federal and Indian Royalty in the Office of the Solicitor of the Department of the Interior in Washington, D.C. He received his Bachelor's degree from the University of Utah in 1975, a Juris Doctor from the University of Michigan Law School in 1978, and a Master of Laws (LL.M.) from George Washington University in 1987. After working in private practice for several years in Salt Lake City following law school, he joined the Office of the Solicitor in November 1983. He has represented the Minerals Management Service since that time.

Valuing oil and gas produced from Federal and Indian lands for purposes of calculating royalty involves application of a complex set of regulations and principles that have developed over a period of decades. Moreover, the legal regime applicable to valuing production from Federal and Indian leases often is different from the legal regime that applies to production from non-Federal (principally private and state) lands. That fact has been a source of dissonance and conflict from time to time, particularly if one's perspective on valuation of production from Federal and Indian leases starts with an assumption that the Federal and Indian regime should be the same as that applicable to private oil and gas leasing.

Understanding the development of the Federal and Indian valuation regulations and the concepts and principles they embody is very helpful in understanding today's regulations and how they apply. This paper tracks the development of legislative provisions, regulations, and royalty valuation concepts with that in mind. Other papers presented during the course of this Institute will discuss several of the provisions and concepts mentioned briefly here in greater depth.

I. THE MINERAL LEASING STATUTES

The Secretary of the Interior ("Secretary") leases Federally-owned lands (not excluded from leasing either by statute or other withdrawal) for exploration for, and development and production of, oil and gas under two principal statutes, depending on whether the leased lands are part of the public domain or are acquired lands.² Public domain lands are leased under the Mineral Leasing Act (MLA), 30 U.S.C. §§ 181 et seq., originally enacted in 1920. Acquired lands are leased on the same terms as public domain lands under the Mineral Leasing Act for Acquired Lands ("Acquired Lands Act"), 30 U.S.C. §§ 351 et seq., enacted in 1946.

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The MLA, at 30 U.S.C. § 226, requires a royalty of "not less than 12½ per centum in amount or value of the production removed or sold from the lease." The reference to "amount" of production refers to the Secretary's authority to take royalty in kind rather than in money (see 30 U.S.C. § 192). While the MMS takes a significant percentage of the royalty accruing to the United States in kind (i.e., MMS accepts physical delivery of the royalty percentage of the oil or gas produced, which MMS then disposes of through sale or other disposition), it receives the majority of royalty in value, i.e., in cash. The question becomes what the proper value of the production is upon which the lessee must calculate the royalty owed. The royalty rate is applied to the volume and value of the oil or gas produced from the lease to determine the amount of royalty owed. In other words:

volume × royalty value × royalty rate = amount owed

Lessees must pay royalties monthly, with payment due by the end of the month following the production month.

We generally refer to both public domain and acquired lands as "onshore" lands, to distinguish them from the offshore Outer Continental Shelf (OCS). There are a few additional special categories of onshore lands that are leased under statutes other than the MLA or the Acquired Lands Act. The most prominent example is certain categories of public domain lands that originally were excluded from leasing under the MLA and became available for lease under later statutes. For example, the MLA excluded lands within the National Petroleum Reserve in Alaska (the former Naval Petroleum Reserve No. 4) under 30 U.S.C. § 181 's exclusion of lands within the naval petroleum reserves. Congress made these lands available for lease in 1980 under 42 U.S.C. § 6508. The valuation regulations that apply to production from leases issued under the MLA or the Acquired Lands Act also apply to production from these specialized categories of lands.

The Secretary leases oil and gas deposits underlying the OCS under the Outer Continental Shelf Lands Act (OCSLA), 43 U.S.C. §§ 1331 et seq., enacted in 1953 and substantially amended in 1978. The OCSLA also requires that the leases provide for a royalty of "not less than 12½ per centum fixed by the Secretary in amount or value of the production saved, removed, or sold." 43 U.S.C. § 1337(a). Though the statute sets a 12½ percent royalty rate as the minimum, most offshore leases not in deep water have a 16-2/3 percent royalty rate. OCS leases yield the substantial majority of oil and gas production from all Federal leases.

Indian tribal lands are leased by the tribes, with the Secretary's approval, under the Indian Mineral Leasing Act (IMLA), 25 U.S.C. §§ 396a-396d , enacted in 1938. Unlike the MLA and the OCSLA, the IMLA does not set a floor royalty rate. Section 396d grants the Secretary the authority to establish the lease terms by rule. See 30 C.F.R. part 211.³

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Indian allotted lands are leased under 25 U.S.C. § 396, enacted in 1909. This very short statutory provision reserves to the Secretary the authority to prescribe the terms upon which leases are to be issued. Like the other mineral leasing statutes, it grants the Secretary general rulemaking authority, which is discussed further below. See 30 C.F.R. part 212. Indian tribal or allottee lessors receive 100 percent of the royalty and other revenues derived from the lease.

II. KEY LEASE TERMS

In addition to the royalty clause required by statute (or, in the case of Indian leases, prescribed by regulation), almost all the leases contain an express term incorporating the Department's regulations, both those in force at the time the lease is issued and those promulgated thereafter. Almost all the leases also expressly reserve to the Secretary the authority and discretion to establish the reasonable value of production for royalty purposes. (These provisions are in different sections of different lease forms, and it is not necessary here to give lengthy citations to the respective sections of successive lease forms.) As a general matter, the Secretary exercises that discretion through rulemaking under the statutory grants of rulemaking authority discussed below.

The reservation of authority to the Secretary to determine the reasonable value of the production on which the lessee must pay royalty is an unusual feature of Federal and Indian leases. Most oil and gas leases entered into between lessees and private lessors do not reserve to the lessor the authority to determine the royalty value of production. The courts have uniformly upheld the Secretary's broad authority and discretion to establish the reasonable value of production for royalty purposes under the statutes, lease terms, and Departmental regulations.⁴ However, the MMS does not possess unlimited discretion. Final agency actions (both rulemakings and administrative adjudications) are subject to judicial review under the Administrative Procedure Act, 5 U.S.C. §§ 701 -706.

In some of the lease forms used in earlier years, the royalty clause that reserved authority to the Secretary to establish the...