CHAPTER 11 DETERMINATION, CALCULATION AND AUDIT OF FEDERAL ROYALTIES: STANDARDS, PROCEDURES AND PRACTICE
| Jurisdiction | United States |
(Mar 1988)
DETERMINATION, CALCULATION AND AUDIT OF FEDERAL ROYALTIES: STANDARDS, PROCEDURES AND PRACTICE
Holland & Hart
Denver, Colorado
Statutory Authority to Conduct Audits.
The United States Department of the Interior has the legal authority (and the legal obligation) to audit the lease accounts for federal oil and gas and coal leases issued pursuant to the Mineral Leasing Act of 1920 and the Minerals Leasing Act for Acquired Lands in order to ensure that all royalties due and payable to the United States have been properly and timely paid.1
The United States Department of the Interior also has the legal authority (and the legal obligation) to audit the lease accounts for oil and gas and coal leases issued pursuant to the Allotted Indian Lands Leasing Act of 1909 and the Unallotted Indian Lands Leasing Act of 1938 in order to ensure that all royalties due and payable to Indian allottees or Indian tribes have been properly and timely paid.2 The Department of the Interior also has the authority to audit Indian oil and gas and coal leases issued pursuant to statutes other than the 1909 and 1938 Acts in order to ensure that royalties on such leases have been properly and timely paid.3
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Where federal or Indian oil and gas leases (as opposed to federal or Indian coal leases) are involved, the Department of the Interior has the independent authority, pursuant to the Federal Oil and Gas Royalty Management Act of 1982 ("FOGRMA"), to audit federal, tribal and allotted oil and gas lease accounts to verify proper and timely royalty payments.4
Delegation of Authority to Conduct Audits Within the Department of the Interior or to States or Tribes.
The Secretary of the Interior has delegated the authority to conduct audits of onshore and offshore federal and Indian oil and gas lease accounts to its constituent agency the Minerals Management Service ("MMS").5 Audits of federal and Indian coal lease accounts are also conducted by the MMS.
Where federal or Indian oil and gas leases are involved, the MMS has the authority to enter into a cooperative agreement with the State wherein the particular federal oil and gas lease is located (or the Indian tribe on whose reservation the Indian lease is located) authorizing the State (or Indian tribe) to cooperate with the MMS in carrying out audits and related investigative and enforcement activities.6 With the permission of the affected Indian tribe, the Department of the Interior and the State may enter into a cooperative agreement with respect to audits and related activities on Indian lands within the State.7
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Where federal or Indian oil and gas leases are involved, the MMS has the authority to delegate all or any part of its audit, investigative and enforcement functions to the State wherein the particular lease is located. However, the State and the MMS cannot conduct duplicative audits.8 The written consent of any affected Indian tribe or allottee is required to support such a delegation as to Indian lands within the State.9
Where a State is conducting an audit of a federal or Indian oil and gas lease account pursuant to a delegation of authority from the MMS, the initial contact letter and the issue letter which starts the formal phase of the audit will be issued by the State. However, the demand letter which concludes the audit will be issued by the MMS. This demand letter is a final decision which may be appealed to the Director of the MMS, and, ultimately, to the Interior Board of Land Appeals.10
The Audit Process—Selection for Audit.
A particular federal or Indian oil and gas or coal lease may have been selected for audit in a variety of ways. The MMS (or a State pursuant to a proper delegation where oil and gas leases are involved) may select a field or area where oil and gas or coal production was high during the proposed audit period, and audit each lease within the field or area. The MMS (or a State) may target certain companies for audit based on the large number of federal or Indian oil and gas or coal leases in which the
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company has had an interest. A particular Indian tribe may request that the Department of the Interior conduct an audit of all oil and gas or coal leases on its lands. At the current time, the MMS' audit strategy is to focus most of its audit resources on the 350-400 payor companies which submit 99% of the total mineral revenues on federal lands (95% of the revenues on Indian lands).11
After selecting a company or area for audit, the MMS (or the State where oil and gas leases are involved) may choose to conduct preliminary audits of a few leases held by the selected company or by all of the companies operating in the selected area. If the preliminary audits do not disclose improperly paid royalties, there may well be no further audits. If, however, the preliminary audits disclose that royalty payments have not been made in accordance with the MMS' interpretation of statutes, regulations and its Notices to Lessees ("NTLs"), the MMS may choose to conduct a series of follow-up audits covering all of the federal and Indian leases held during the audit period by the operators in question.
The lessee or operator of a federal or Indian oil and gas lease (offshore and onshore) is generally required to maintain its records for six years after their generation.12 Records pertaining to federal or Indian "solid minerals," including coal, must also generally be maintained for six years.13 This six-year
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record keeping limitation normally defines the outer limits of an audit.
The Audit Process—Current Issues.
In the oil and gas context, the MMS is presently focusing on several major issues in its conduct of ongoing audits.
Waste. For gas produced from federal or Indian oil and gas leases which was "unavoidably lost" prior to October 22, 1984, the Department of the Interior continues to take the position that the producer should pay the United States or the Indian lessor the full value of the gas.14 For gas which was "unavoidably lost" subsequent to October 22, 1984, the Department of the Interior allows the producer to pay royalties only on the value of the gas which was "unavoidably lost," but requires the producer to file a plan to capture future gas production so that it is not also "unavoidably lost." If the Department of the Interior determines that a capture plan would have been economically viable for gas "unavoidably lost" after October 22, 1984, but no plan was filed (or the...
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