CHAPTER 10 FEDERAL COAL TRANSPORTATION AND BENEFICIATION (WASHING) ALLOWANCE REGULATIONS

• Jurisdiction: United States

Royalty Valuation and Management
(Mar 1988)
CHAPTER 10
FEDERAL COAL TRANSPORTATION AND BENEFICIATION (WASHING) ALLOWANCE REGULATIONS
John S. Kirkham
Van Cott, Bagley, Cornwall & McCarthy
Salt Lake City, Utah

I. INTRODUCTION

The scope of this presentation is limited to an analysis of the coal transportation and beneficiation allowance regulations proposed as part of the coal product valuation regulations to be published by the Minerals Management Service ("MMS"). No attempt is made to discuss accounting issues relating to the regulations. The expressed intent of these new regulations was to update, consolidate, and clarify existing regulations in order to provide a comprehensive and consistent valuation policy. With respect to the washing and transportation allowances there is legitimate concern whether or not the intent was accomplished. The regulations as proposed leave many unanswered questions and are so vague and uncertain, in certain respects, that they will require significant MMS explanation and clarification as to their application on a case by case basis.

At one stage of the administrative process leading to the promulgation of the regulations, a single set of transportation allowance regulations was to be applicable to all lease products including oil and gas, solid minerals, and geothermal resources. The transportation regulations have now been segregated for different lease products and it is assumed that separate transportation allowance regulations will be published for coal. At one time, there was also discussion of what could generically be referred to as beneficiation allowance regulations that would apply to all lease products.

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However, when the coal regulations were segregated from the other lease product regulations, the beneficiation allowance was limited strictly to a coal washing allowance. Therefore, as presently proposed, the only beneficiation operations that will be included in the allowance regulations will be those regarding coal washing.

The ultimate determination of value for royalty calculation purposes is obviously dependent upon numerous factors in addition to the transportation and washing allowances. Because those factors are discussed in other presentations at this Special Institute, the author has deliberately avoided any discussion of those other elements required for the calculation of royalties. However, the point of royalty determination is a critical element in both the transportation and washing allowance regulations and of necessity must be mentioned as a part of this paper.

The definition of gross proceeds specifically precludes claims for certain other types of "beneficiation allowances" that might otherwise be considered as legitimate deductions from the total consideration paid in determining value for royalty payment purposes. Given the proposed definition of "gross proceeds" no consideration will be given in this paper to arguments in support of such potential deductions as the costs incurred for crushing, storing, mixing, loading, and other similar acts performed by the lessee in the preparation of the coal.

II. HISTORICAL BACKGROUND

A. Statutory

The detailed historical background of ad valorem federal royalties is discussed in other presentations at this Special Institute. For purposes of this paper, it is sufficient to point out that ad valorem coal royalties found there statutory genesis in the Federal Coal Leasing Amendments Act ("FCLAA") when it was adopted in 1976.¹ In that statute, as originally enacted and as presently codified, there is no specific mention of allowances. Instead, the statute simply states that the percentage royalty will be applied to "the value of coal as defined by regulation."²

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The coal royalty provisions, adopted by the FCLAA, are unique in at least two respects. First, they are unique in their reference to the regulations for a determination of value. Second, they are unique in the exclusive reference to value as the basis for the royalty. Other provisions of the Mineral Leasing Act, such as those applicable to oil and gas, do not rely exclusively on "value" and make no reference to the regulations. As an example, reference is made to those oil and gas provisions that base royalty on a percentage of the "amount or value of the production,"³ and those that refer to a percentage "of all the oil or gas produced."⁴ These statutory provisions relating to oil and gas appear to anticipate the possibility that royalty could be taken "in kind." The coal statute does not appear to authorize "in kind" royalties.

It should be noted that while this distinction is clear in the statute, it was apparently missed by MMS in the preparation of the coal valuation regulations. The proposed definition of "ad valorem lease" contained in the coal regulations would seem to refer to the oil and gas concept of a royalty based upon a percentage of the "amount or value of the production" rather than strictly the value. The distinction could have a significant impact on the conceptual foundation for the allowances provided in the regulations. Simply stated, the distinction would arise because if a royalty is taken "in kind" the operator is washing and transporting the governments coal while a royalty based on value is simply a percentage of a specified dollar amount.

Therefore, from looking at the coal statute it would appear that the Secretary can define value in the regulations at any point and on any basis, so long as it is not done in an arbitrary and capricious fashion and is based upon a permissible construction of the statute.⁵ On the other hand, in the case of oil and gas, the royalty can be either "in kind" or "at value." Under that statute, the theoretical basis for allowances in the oil and gas context is supported by arguments such as those relying on a "well head" value or a net back method that determines value as if the royalty were taken in kind as it left the leasehold.⁶ Under the coal statute, there is no similar theoretical foundation, and it would appear that the Secretary is free to determine value on any basis that satisfies the legal standards applicable to the adoption of regulations.

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Since the royalty valuation regulations were proposed in January 1987, certain industry groups suggested an alternative method of valuation using percentage depletion as defined in the Internal Revenue Code (the "Code"). It is interesting, for purpose of this paper, to note that the Code does specifically provide for "allowable deductions" when determining gross income for depletion calculation purposes.⁷ In this regard, the Code definition of gross income from the property distinguishes between gross income as defined for purposes of oil and gas well and geothermal deposits and gross income from mining. The statutory provision relating to the calculation of percentage depletion also contains detailed provisions with respect to the various expenses that might be incurred by a mine operator and how they are to be utilized in the calculation of value for percentage depletion purposes. Therefore, while certain federal statutes do contain detailed provisions with respect to the use of transportation and beneficiation allowances in the determination of value, no such provisions are contained in the Mineral Leasing Act with respect to the valuation of coal for royalty payment purposes.

B. Regulatory

There is virtually no historical background in the regulations for allowances in the determination of coal value for royalty purposes. Prior to the enactment of the FCLAA, the Bureau of Land Management's ("BLM") regulations simply provided "royalty rates will be determined on an individual case basis prior to lease issuance."⁸ Under that regulation, certain leases were issued with ad valorem royalty provisions and those leases gave rise to the early decisions with respect to allowances in the context of coal royalty calculations.⁹

Prior to 1975, the U.S. Geological Survey regulations only contained requirements with respect to the weighing or measuring of coal. Thus, the only allowance mentioned related to a weighing allowance for waste material.¹⁰ A few months before the FCLAA was enacted, the U.S. Geological Survey adopted new regulations which, for the first time, contemplated the payment of royalty on a value basis. The regulations adopted in May, 1976, contemplated that value for royalty payment purposes would be the gross value at the point of sale. However, if additional processing occurred prior to sale, then the lessee was allowed to deduct the cost of processing which exceeded the cost of primary crushing, storing, and loading in the determination of value for royalty

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purposes. Under those regulations, the mining supervisor had the prerogative to allow such deductions only when the lessee provided him with an accurate account of the costs incurred.¹¹ With the implementation of the FCLAA, the requirement to define the value of coal in the regulations caused the Interior Department to make additional changes and recodifications in the regulations. The present regulations were adopted July 30, 1982,¹² amended August 5, 1983,¹³ redesignated September 16, 1983,¹⁴ and are now codified at both 43 C.F.R. Section 3485.2 and 30 C.F.R. Section 203.200. The only difference between the two sets of regulations is that the BLM Regulations refer to the authorized officer while the MMS regulations refer to the district mining supervisor. The relevant portions of the regulations as now found at 43 C.F.R. Section 3485.2(f) and (h) read as follows:

(f) Where Federal Royalty is calculated on a percentage basis, the value of coal for Federal royalty purposes shall be the gross value at the point of sale, normally the mine, except as provided at paragraph (h) of this section. For captive operations or other than arms-length transactions, the authorized officer shall determine gross...