CHAPTER 11 FEDERAL ROYALTY PENALTIES: THE (EVER-INCREASING) RISKS INVOLVED IN ROYALTY UNDERPAYMENTS
| Jurisdiction | United States |
(2000)
FEDERAL ROYALTY PENALTIES: THE (EVER-INCREASING) RISKS INVOLVED IN ROYALTY UNDERPAYMENTS
Stephen R. Ward **
Gardere & Wynne, L.L.P.
Tulsa, Oklahoma
[Page 11-1]
Valuation of royalty is difficult, and even legal giants differ. In Pennsylvania Coal Co. v. Mahon, 260 U.S. 393 (1922), Justice Holmes, speaking for the Supreme Court, stated that what made a mineral interest have value was the right to make a profit. Justice Brandeis disagreed, and said "Values are relative." Disagreement as to value continues today. 1
INTRODUCTION
If it ever existed, the day has long passed when disputes over the valuation of federal oil and gas production for royalty purposes were the stuff of mere disagreements between reasonable minds. Increasingly over the last two decades, valuation has become the subject of not only litigation and regulatory disputes, but politics as well. Since the mid-1990s, there has been a concerted effort to attempt to capture additional royalty dollars through a variety of means, including reinterpretation of the 1988 valuation regulations, increasing audit and enforcement activities, and the promulgation of new regulations. In response, there has been a boom in litigation under the federal valuation regulations.
With all of these developments, the range of possible penalties for underpaying royalties has increased dramatically, along with the attendant financial risks for royalty payors. Until a few years ago, the standard penalty for undervaluing federal production for royalty purposes consisted mainly of additional royalties, with interest through the issuance of administrative "orders to pay." Today, a federal royalty payor may face not just the risk of large interest payments, but also much more severe penalties such as those imposed under the federal False Claims Act. In the new adversarial climate, the interpretation of the federal valuation regulations has become increasingly uncertain. The chief certainty is that there will be disagreement.
I. A Decade of Change in Federal Royalty Regulation
While recent federal royalty policy and administration has been characterized by an adversarial relationship between regulator and regulated, the opposite was true for much of the history of federal mineral regulation. Federal mineral leasing began with the enactment of the Mineral Leasing Act of
[Page 11-2]
1920 (MLA), which, like all subsequent foundational statutes in the field, provided only the broadest possible outline of the methodology to be used to value oil and gas for royalty purposes. Congress thus left the specifics of valuation to be resolved contractually by the parties to oil and gas leases and through administrative regulations promulgated by the Secretary of the Interior.
With some exceptions, the basic valuation methodology for crude oil that had been established by the late 1930s and early 1940s remained in effect until new regulations were promulgated in 1988. During this era, crude oil was traded at posted prices, and there was substantial consensus between regulators and royalty payors about how the market operated and about how crude oil was to be valued for royalty purposes. Eventually, though, changes began to occur in the factors that had fostered predictability and certainty in the valuation process.
As early as the 1960s, there was increasing criticism of the collection performance of the primary administrator of federal royalty programs, the United States Geological Survey (USGS). Nevertheless, another decade or more passed before significant changes began to occur in federal royalty programs. A major impetus for change came from the so-called "energy crisis" of the 1970s. As the United States became more and more of a net crude oil importer, and as the cartel of oil exporting countries gained strength, crude oil prices began to respond dramatically. This resulted in a number of destabilizing changes in the once-predictable markets. As gasoline prices rose, royalty valuation and collection became a political issue, particularly in California.
In 1975, the State of California and the City of Long Beach initiated litigation to attempt to prove, among other things, that seven major oil companies had conspired to keep posted prices low and that the state and the city, as recipients of a share of federal royalties, had been damaged. Six of the companies reached settlements of this undervaluation litigation — known as Long Beach I and Long Beach II — between 1984 and 1991, and the remaining company won a verdict at trial. In 1986, with the Long Beach litigation still underway, the MMS contacted California officials and other sources to obtain information for an assessment of the use of posted prices as the royalty value basis. After its review, the MMS "concluded that posted prices fairly represented royalty value".2 However, in 1993, following settlements between the state and city and five of the company defendants in the Long Beach litigation, the MMS revisited the issue.3 The MMS's preliminary conclusion was that it "could not definitively state that postings were underpriced or that royalties had been underpaid."4 However, the MMS and state officials agreed to seek input from other agencies and to attempt to obtain access to sealed records in the Long Beach II litigation.5 As a result, an "interagency" team was formed in 1994 to "determine conclusively whether the posted prices used by the major oil companies in California to value crude oil from Federal leases reflect market value."6
[Page 11-3]
In its final report in May 1996, the Interagency Team recommended in general that the MMS recompute royalties paid on California production for time periods dating to 1980.7 Among its more significant conclusions, the task force recommended revaluing production by using the price of Alaskan North Slope crude oil, adjusted for quality and transportation, instead of posted prices.8 The MMS began implementing the task force's recommendations in July 1996.9 The MMS's subsequent attempt to collect additional royalties on California production had a larger significance in at least two key respects: (1) it represented a departure from the MMS's practice of accepting posted prices under both the pre-1988 regulations and the 1988 regulations, and (2) it represented a change — unprecedented in scope — by the administrator of federal royalty programs in the way it interpreted and applied the valuation regulations.
The Interagency Team's work and the MMS's decision of the 16 defendants to revalue California production, while significant events in themselves, are probably viewed most appropriately as reactions to overall events in the 1990s rather than as precipitating events. Partly as a fallout of the Long Beach litigation, a wave of litigation began in which claims of royalty underpayment were prosecuted against energy companies. Beginning in 1996, the first of several sealed actions was filed against major energy companies asserting claims involving royalty valuation under the federal False Claims Act (FCA). These actions — known as quit tam actions — were brought under a provision of the FCA which allows private "relators" to pursue claims on behalf of the United States government. In essence, these actions — brought by relators including individuals who had been involved in the Long Beach litigation and other royalty issues in California — alleged that the companies had made false claims to the United States on their crude oil royalty valuation reports. Eventually, the Justice Department intervened against some of the defendants and assumed responsibility for prosecuting those actions. These lawsuits account for arguably the most significant penalty proceedings ever brought against royalty payors by the federal government.
By the mid 1990s, then, the factors that once had contributed to stability in royalty collections had disappeared. The MMS was moving away from posted prices — long the stable valuation standard. Interpretation of the valuation regulations was no longer predictable or certain. Aggressive enforcement actions, as well as the false claims litigation and other litigation, had destroyed the consensus the royalty payors believed had existed.
By early 2000, many of the company defendants in the crude oil qui tam litigation had reached global settlements with the federal government and the relators. Yet, a new round of qui tam actions involving natural gas was just beginning.10 Litigation spawned by the California re-audits in 1996 also continued. In addition, the MMS published new crude oil valuation regulations in March 2000, which to a large degree adopted the downstream valuation approach urged by California and which were opposed by industry. Both proponents and opponents likely could agree that the new
[Page 11-4]
regulations do not promote predictability and certainty in valuation, at least to the extent that existed in the era of posted prices. All of these events show that the era of royalty litigation, both public and private, has not yet ended.
II. Statutory Jurisdiction to Enforce Federal Minerals Laws
The last decade has seen something of de-federalization in the enforcement of the federal royalty laws. The advent of false claims actions, filed by private qui tam relators, has vastly broadened the possibilities for entities other than federal regulators to enforce and influence royalty policy. Still, the primary responsibility for administering royalty programs lies with the Secretary of the Interior and the Attorney General, and to a lesser extent and under certain circumstances, with states.
A. Enforcement of Mineral Laws by the Secretary of the Interior and His or Her Delegees
The Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA), as well as other statutes, make the Secretary of the Interior primarily...
To continue reading
Request your trial