CHAPTER 14 ENACTMENT OF THE NTL-5 GAS ROYALTY ACT OF 1987

• Jurisdiction: United States

Royalty Valuation and Management
(Mar 1988)
CHAPTER 14
ENACTMENT OF THE NTL-5 GAS ROYALTY ACT OF 1987
David T. Deal
American Petroleum Institute
Washington, D.C.

On January 6, 1988 President Reagan signed Public Law 100-234 bringing to an end, a controversy which had been simmering since 1982. At issue was Notice to Lessees No. 5 (NTL-5), which since 1977 had been the Minerals Management Service (MMS) standard for royalty valuation of onshore natural gas production. Since under NTL-5 the value of production for royalty purposes was pegged at federal ceiling prices, strict application of NTL-5 presented fundamental problems for producers after gas prices started to drop in 1982.

To bring royalty value determinations more in line with the proceeds actually received by producers in this falling market, the MMS in July 1986 first limited strict application of NTL-5 prospectively for production after August 1986. When the MMS then proposed in January 1987 to roll back that relief to cover the 1982-1986 period, however, the controversy came to a head.

Before the issue had been resolved, the issue had shifted from the MMS to Congress, where it attracted the keen interest of Congressional appropriations committees and the committees with jurisdiction over royalty matters and brought to a temporary halt the MMS' generic product valuation rulemaking.

I. BACKGROUND

The NTL-5 issue had its roots in 1977 when the MMS' predecessor, the United States Geological Survey, published NTL-5.¹ Published at a time when gas prices were increasing, NTL-5 applied to federal and most Indian onshore leases,² providing that royalties for gas production after June 1, 1977 would be based on contract proceeds or the applicable federal ceiling price, whichever was higher.³ Although subject to MMS reinterpretation to conform with passage of the Natural Gas Policy Act (NGPA) in 1978,⁴ NTL-5 was never amended and posed no real problem for producers so long as gas prices were at or near federal ceiling prices. But once gas prices began to drop around 1982, a real problem had been born.⁵

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II. 1986 RULEMAKING

Given the reversal of gas prices, the MMS itself in early 1983 recognized the need to amend NTL-5, and on a case-by-case basis advised lessees that contract proceeds, not NGPA ceiling prices, would be the standard for valuation.⁶ Indeed, the MMS' reliance on contract proceeds for NTL-5 purposes was consistent with a theme central to the then emerging amendments to the generic product valuation regulations.⁷

However, the MMS did not publish a formal proposal to cure the NTL-5 problem until January 1986.⁸ Central to the 1986 NTL-5 proposal was the effective date issue: Should NGPA ceiling prices be abandoned as the strict standard for valuation from the time gas prices started to drop or should relief be prospective only, i.e., only for production after promulgation of a final rule? Although the MMS recognized retroactive relief as one alternative,⁹ it was clear that the MMS favored prospective relief.

The 1986 NTL-5 proposal attracted a substantial number of public comments. The gas producers urged the MMS to make any change effective retroactively; as expected, states and Indian tribes, who receive a sizeable share of royalties collected by the MMS,¹⁰ argued that only prospective relief was appropriate. In July 1986 the MMS published a final rule limiting NTL-5 relief to gas production after August 1, 1986,¹¹ citing several reasons for selecting the prospective relief alternative,¹² Left unaddressed, however, was the problem presented by the gap between market prices and NGPA ceiling prices, a gap that widened during the period 1982-1986, as gas prices dropped and ceiling prices rose.

III. 1987 RULEMAKING

Industry reaction to the 1986 modification to NTL-5 was intense. Some companies contemplated litigation; others sought reconsideration by the MMS. The latter strategy worked and in January 1987 the MMS published a new NTL-5 proposal which contemplated rolling back the effective date, using a schedule of dates varying according to NGPA gas category.¹³

State and Indian tribes were outraged at the proposed turnabout and MMS presentation of the fiscal impact of the new proposal did not help. In announcing the new proposal, the MMS estimated that the foregone royalty revenues would be around $140 million overall, of which an estimated $14 million was associated with Indian leases and around $128 million was associated with federal onshore leases.¹⁴ Furthermore, it was estimated that implementation of the MMS proposal would necessitate dealing with about $22 million in refunds, to account for royalties thought already paid under NTL-5 for the 1982-1986 period. Stated more simply, under the MMS estimates not only would the Federal

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Government and other royalty beneficiaries forego collection of sizeable royalty revenues but they would have to refund some amounts already collected.

Just as the 1986 NTL-5 proposal had, the 1987 NTL-5 proposal generated a firestorm of comments. Many states, local governments and Indian tribes vigorously attacked the proposal; industry and others including Senator Dole, New Mexico, Arizona, and the Federal Energy Regulatory Commission, just as vigorously supported the MMS proposal. At least one party, the State of Colorado first opposed, then supported the proposal. In any event, both sides filled the administrative record with an incredible range of arguments, leaving no legal or policy stone unturned. Appendix A is a distillation of the more interesting comments.

Unconvinced that the MMS would be swayed by their arguments, the states and Indian tribes in Spring 1987 turned to Congress. Several factors made this a powerful strategy. For several months, Congress, especially on the House of Representatives side, had become increasingly critical of the MMS' Royalty Management Program. Specifically, both the House Interior Appropriations Subcommittee, chaired by Mr. Yates, and the House Interior and Insular Affairs Committee, chaired by Mr. Udall, had grown increasingly impatient with the MMS' conversion of its Auditing Financial System (AFS) for use on its new mainframe computer which, because of some early MMS management mistakes, had cost millions more than anticipated, incurred implementation delays and generated substantial coordination problems among MMS, the states, and the Indians. More fundamental, however, was the lingering perception that the MMS was permitting gross underpayment of royalties by industry, an allegation examined by the Linowes Commission in 1982 but never established.¹⁵

In addition, the MMS had also just advanced to the next stage of its generic product valuation rulemaking by publishing comprehensive and controversial oil and gas proposals.¹⁶ If that were not enough, while many states and Indian tribes were highly critical of the oil and gas valuation proposals, the coal industry was complaining bitterly about MMS' treatment of coal valuation. Indeed, MMS' early 1987 product valuation activity—NTL-5 and otherwise—brought to a head acrimony on several fronts that had developed in the course of the deliberations of the Secretary of the Interior's Royalty Management Advisory Committee.¹⁷

In sum, the time was ripe for interests displeased with the MMS to merge their concerns and go to Congress with a tale of gross mismanagement by the MMS, asserting a windfall for industry at a tremendous cost to the taxpayers. Indeed, the convergence of oil industry, coal industry, state and Indian interests so confounded the situation that the MMS' plans to publish a final NTL-5 rule and final generic oil and gas valuation rules in the Summer of 1987 came to an abrupt halt. In June 1987 Congress

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passed the Supplemental Appropriations Act for Fiscal Year 1987¹⁸ which, among other things, directed the MMS to publish new generic oil and gas valuation proposals in August 1987 and prohibited the MMS from implementing changes in any product valuation rules, including NTL-5, before November 1, 1987. To make matters worse, the House appropriations bill for Fiscal Year 1988 threatened to extend the moratorium through November 1988.¹⁹

IV. MMS SETTLEMENT INITIATIVES

With a moratorium until November 1987 in place, and the prospect of a moratorium until November 1988 on the horizon, the MMS sought to strike a political compromise. On July 2, 1987, MMS senior staff met with several Congressional staff members and representatives from key states impacted by the NTL-5 issue and crafted an...