CHAPTER 15 FEDERAL ROYALTY ACCOUNTING FOR DISPROPORTIONATE SALES FROM FEDERAL UNITS AND CORRESPONDING STATE ISSUES (TAKES vs. ENTITLEMENTS)

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management Vol. 2
(Jan 1992)
CHAPTER 15
FEDERAL ROYALTY ACCOUNTING FOR DISPROPORTIONATE SALES FROM FEDERAL UNITS AND CORRESPONDING STATE ISSUES (TAKES vs. ENTITLEMENTS)¹
James C. T. Hardwick and Patricia Dunmire Bragg
Hall, Estill, Hardwick, Gable, Golden & Nelson, P.C.
Tulsa, Oklahoma
and John L. Price
Minerals Management Service
Denver, Colorado

PART ONE

OVERVIEW

SYNOPSIS

I. INTRODUCTION

II. THE BASICS OF ROYALTY ACCOUNTING

A. OVERVIEW

B. DESCRIPTION OF SPACING, POOLING AND HOW UNITS ARE CREATED

1. General

2. Federal Units

C. OTHER AGREEMENTS THAT IMPACT ROYALTY ACCOUNTING

D. LEASE MAINTENANCE ISSUES

III. THE ELEMENTS AND METHODS OF ROYALTY ACCOUNTING

A. ELEMENTS OF ROYALTY ACCOUNTING

1. Volume Allocation Element

2. Valuation Element

3. Royalty Rate Element

4. Payment Element

B. METHODS OF ROYALTY ACCOUNTING

1. Takes Method

2. Pure Entitlements Method

3. Blanchard Method

4. MMS Method

C. ROYALTY ACCOUNTING MATRIX

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PART TWO

FEDERAL LEASES

IV. THE ROYALTY VALUATION REGULATIONS

A. OVERVIEW

B. INTERRELATIONSHIP BETWEEN STATUTES, REGULATIONS, MMS PAYOR HANDBOOK, MMS POLICIES, LEASES, AND UNITS

C. ROYALTY ACCOUNTING FOR UNIT PRODUCTION PRIOR TO MARCH 1, 1988

1. Reporting Mechanism

2. 1982 Payor Handbook

3. 1984 Payor Handbook

4. 1986 Payor Handbook

5. Blanchard

D. HISTORY OF THE 1988 RULEMAKING PROCESS

Royalty Management Advisory Committee

E. THE 1988 REGULATIONS—30 C.F.R. § 202.150

V. THE MMS METHOD OF ROYALTY ACCOUNTING

A. VOLUME ALLOCATION ELEMENT—PRODUCTION REMOVED FROM A LEASE

B. VALUATION ELEMENT

1. Tracing Method For Valuation Of Production

2. Valuation Of Production Removed From A Lease By The Lessee

3. Valuation Of Production Removed From A Lease By A Party Other Than The Lessee

4. Implications On Value During Make-Up

5. Alternative Methods Of Valuation

C. ROYALTY RATE ELEMENT

D. PAYMENT ELEMENT—REPORTING

1. Production And Operations

2. Royalty

3. Payor Information Form (PIF)

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VI. INDUSTRY EXPERIENCE UNDER 1988 ROYALTY VALUATION REGULATIONS

A. INDUSTRY PERSPECTIVE

1. General

2. Accounting And Reporting Complexities

3. Conclusion

B. INDUSTRY PROPOSALS

VII. CURRENT REGULATORY ALTERNATIVES UNDER CONSIDERATION

A. OVERVIEW

B. BENCHMARKED ENTITLEMENTS ALTERNATIVE

C. ADVANCED MINIMUM PAYMENTS ALTERNATIVE

D. PURE TAKES ALTERNATIVE

E. OPERATOR AS SINGLE PAYOR ALTERNATIVE

F. MODIFIED TAKES ALTERNATIVE

G. TAKES WITH MMS BILLING ALTERNATIVE

H. WEIGHTED AVERAGE PRICE ALTERNATIVE—TWO VARIATIONS

VIII. FEDERAL LEASE MAINTENANCE ISSUES

PART THREE

FEE LEASES

IX. DETERMINATION OF APPLICABLE ACCOUNTING METHOD BY ANALYSIS OF THE ACCOUNTING ELEMENTS

A. VOLUME ALLOCATION ELEMENT

1. Compulsory Units

a. Oklahoma

b. Louisiana

c. Other States

2. Units Formed Under Pooling Clauses And Voluntary Agreements

a. Units Under Pooling Clauses

b. Units Under Voluntary Agreements

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B. VALUATION ELEMENT

C. ROYALTY RATE ELEMENT

D. PAYMENT ELEMENT

E. SUMMARY

X. OTHER FACTORS AFFECTING SELECTION OF ROYALTY ACCOUNTING METHOD FOR FEE LEASES

A. ROYALTY CLAUSE

B. DIVISION ORDERS

C. GAS BALANCING AND OPERATING AGREEMENTS

D. NATURE OF UNITIZED TITLE

XI. RECONCILING CONFLICTS BETWEEN THE MMS AND STATE ACCOUNTING METHODOLOGIES

A. SUPREMACY AND PREEMPTION BY FEDERAL LAW

B. ILLUSTRATIONS OF THE EFFECT OF PREEMPTION

C. ENTITLEMENTS BY CONTRACT

XII. FEE LEASE MAINTENANCE ISSUES

PART FOUR

INCIDENTAL ISSUES

XIII. IMPACT OF THE MMS ACCOUNTING METHOD ON NON-OPERATING INTERESTS

A. OVERRIDING ROYALTY INTERESTS

B. IMPACT OF GAS BALANCING AND OPERATING AGREEMENTS

C. AN ARGUMENT FOR TAKES ACCOUNTING FOR NON-OPERATING INTERESTS

D. VALUATION OF NON-OPERATING INTERESTS

E. OBLIGATION TO PAY NON-OPERATING INTERESTS

F. OTHER NON-OPERATING INTERESTS ISSUES

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G. CARRIED INTERESTS: PAYOUT STATUS UNDER JOINT OPERATING, FARMOUT AND OTHER CONTRACTUAL AGREEMENTS

XIV. IMPACT OF THE MMS ACCOUNTING METHOD ON RIGHTS AND DUTIES BETWEEN OVERTAKING AND UNDERTAKING PARTIES

A. UNDER GAS BALANCING AGREEMENTS

B. UNDER OPERATING AGREEMENTS WITHOUT GAS BALANCING AGREEMENTS

XV. IMPACT OF THE MMS ACCOUNTING METHOD ON GROSS PRODUCTION AND SEVERANCE TAX PAYMENTS

XVI. ACCOUNTING METHODS FOR INCOME TAX PURPOSES

A. FEDERAL INCOME TAX REPORTING

B. THE IRC § 29 TAX CREDIT

GLOSSARY OF TERMS

EXAMPLES OF VARIOUS METHODS OF PAYING MMS ROYALTY

FACTS 1

EXAMPLE 1—MMS ROYALTY COMPUTED UNDER "TAKES/ACTUAL SALES" METHOD

EXAMPLE 2—MMS ROYALTY COMPUTED BY MMS PAYOR HANDBOOK METHOD

EXAMPLE 3—MMS ROYALTY COMPUTED ON "BLANCHARD/WEIGHTED AVERAGE PRICE" METHOD

EXAMPLE 4-A—MMS ROYALTY COMPUTED ON "ENTITLEMENTS" UTILIZING BENCHMARK PRICE FOR UNDERDELIVERIES

EXAMPLE 4-B—MMS ROYALTY COMPUTED ON "ENTITLEMENTS" UTILIZING OWN SALES PRICE FOR UNDERDELIVERIES

FACTS 2

EXAMPLE 5—MMS ROYALTY COMPUTED UNDER "TAKES/ACTUAL SALES" METHOD

EXAMPLE 6—MMS ROYALTY COMPUTED BY MMS PAYOR HANDBOOK METHOD

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EXAMPLE 7—MMS ROYALTY COMPUTED ON "ENTITLEMENTS" UTILIZING BENCHMARK PRICE FOR UNDERDELIVERIES

EXAMPLE 8—MMS ROYALTY COMPUTED ON "ENTITLEMENTS" UTILIZING OWN SALES PRICE FOR UNDERDELIVERIES

FACTS 3

EXAMPLE 9—MMS ROYALTY COMPUTED UNDER "TAKES" METHOD

EXAMPLE 10—MMS ROYALTY COMPUTED BY MMS PAYOR HANDBOOK METHOD

EXAMPLE 11—MMS ROYALTY COMPUTED ON "ENTITLEMENTS" UTILIZING BENCHMARK PRICE FOR UNDERDELIVERIES

EXAMPLE 12—MMS ROYALTY COMPUTED ON "ENTITLEMENTS" UTILIZING OWN SALES PRICE FOR UNDERDELIVERIES

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TABLE OF AUTHORITIES

CASESAmoco Production Co. v. Thompson, 516 So. 2d 376 (La. App. 1987), writ denied, 520 So. 2d 118 (La. 1988) 15-10, 15-51, 15-51Amoco Production Co. v. Thompson, 566 So. 2d 138 (La. Ap. 1st Cir.), writ denied, 571 So. 2d 627, 571 So. 2d 628 (La., Nov. 30, 1990) 15-50Apache Gas Products Corp. v. Oklahoma Tax Comm'n., 509 P.2d 109 (Okla. 1973) 15-63Arkansas Louisiana Gas Co. v. Southwest Natural Production Co., 221 La. 608, 60 So. 2d 9 (1952) 15-50, 15-51, 15-64, 15-65, 15-69, 15-74Beren v. Harper Oil Co., 546 P.2d 1356 (Okla. App. 1975) 15-10Brown v. Smith, 174 S.W.2d 43 (Tex. 1943) 15-75Capital Cities Cable, Inc. v. Crisp, 467 U.S. 691 (1984) 15-76Carpenter v. Shaw, 280 U.S. 363 (1930) 15-97De Mik v. Cargill, 485 P.2d 229 (Okla. 1971) 15-85Diamond Shamrock Exploration Corp. v. Donald P. Hodel, et al., 853 F.2d 1159 (5th Cir. 1988)) 15-22Dodds v. Ward, 418 P.2d 629 (Okla. 1966) 15-81Exxon Corp. v. Middleton, 613 S.W.2d 240 (Tex. 1981) 15-62, 15-68, 15-70First National Bank in Dallas v. Kinabrew, 589 S.W.2d 137 (Tex. Civ. App. 1979) error ref'd nre (1980) 15-86Florida Lime and Avocado Growers, Inc. v. Paul, 373 U.S. 132 (1963) 15-76Gazin v. Pan American Petroleum Corp., 367 P.2d 1010 (Okla. 1961) 15-82Harry Bourg Corp. v. Mobil Exploration & Producing North America, Inc., Civil Action No. 86-4669 (La. 1987) 15-52, 15-84Henry v. Ballard & Cordell Corp., 418 So. 2d 1334 (La. 1982) 15-61Hillard v. Stephens, 637 S.W.2d 581 (Ark. 1982) 15-61

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Holmes v. Kewanee Oil Co., 233 Kan. 544, 664 P.2d 1335 (1983) 15-71Hoult v. Rich, 161 Kan. 587, 170 P.2d 834 (1946) 15-87Imperial Colliery v. OXY USA Inc., 912 F.2d 696 (4th Cir. 1990) 15-62Lightcap v. Mobil Oil Corp., 221 Kan. 448, 562 P.2d 1, cert. denied, 454 U.S. 876 (1977) 15-61, 15-61Matzen v. Hugoton Production Co., 182 Kan. 456, 321 P.2d 576 (1958) 15-61McVicker v. Horn, Robinson & Nathan, 322 P.2d 410 (Okla. 1958) 15-82Moncrief v. Pasotex Petroleum Co., 280 F.2d 235 (10th Cir.) cert. denied, 364 U.S. 912 (1960) 15-43, 15-82Monsanto Chemical Co. v. Southern Natural Gas Co., 234 La. 939, 102 So.2d 223 (La. 1958) 15-73Montana Power Co. v. Kravik, 179 Mont. 87, 586 P.2d 298 (Mont. 1978) 15-62Oklahoma Tax Commission v. Texas Co., 336 U.S. 342, reh'g denied, 336 U.S. 958 (1949) 15-98Panhandle Eastern Pipe Line Company, et al. v. State, et al., No. CIV-85-2659-P (W.D. Okla. 1988) 15-49, 15-67Pasternak v. Lear Petroleum Exploration, Inc., 790 F.2d 828 (10th Cir. 1986) 15-88Pierce v. Texas Pacific Oil Co., Inc., 547 F.2d 519 (10th Cir. 1976) 15-13, 15-63-66, 15-69, 15-79Pogo Producing Co. v. Shell Offshore, Inc., 898 F.2d 1064 (5th Cir. 1990) 15-10Puckett v. First City National Bank of Midland, 702 S.W.2d 232 (Tex. Civ. App. 1985) error ref'd nre (1986) 15-44, 15-58-59, 15-72, 15-74, 15-75Shell Oil Co. v. Corporation Commission, 389 P.2d 951 (Okla. 1963) 15-13, 15-19, 15-46-49, 15-64, 15-69, 15-74Silkwood v. Kerr-McGee Corp., 464 U.S. 238, reh'g denied, 465 U.S. 1074 (1984) 15-76

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Sinclair Crude Oil Co. v. Oklahoma Tax Commission, 326 P.2d 1051 (1958) 15-98Smith v. Davis, 323 U.S. 111 (1944) 15-98State ex rel. Superior Oil Co. v. Texas Gas Transmission Corp., 136 So.2d 55 (La. 1961) 15-50Superior Oil Co. v. Cox, 307 So. 2d 350 (La. 1975) 15-5TXO Production Corp. v. Prickette, 653 S.W.2d 642 (Tex. Civ. App. 1983) 15-58-59, 15-72Tara Petroleum Corp. v. Hughey, 630 P.2d 1269 (Okla. 1981) 15-61Tenneco Oil Co. v. District Court of Twentieth Judicial District, 465 P.2d 468 (Okla. 1970) 15-74Tenneco Oil Co. v. Humble Oil & Refining Co., 449 P.2d 264 (Okla. 1969) 15-87Texas Oil & Gas Corp. v. Vela, 429 S.W.2d 866 (Tex. 1968) 15-62, 15-70Thomas v. Huddleston, 65 Okla. 177, 164 P. 106 (1916) 15-87Transcontinental Gas Pipe Line Corp. v. State Oil & Gas Board of Mississippi, 474 U.S. 409, reh'g denied, 475 U.S. 1091 (1986) 15-76United Petroleum Exploration, Inc. v. Premier Resources, Ltd., 511 F. Supp. 127 (W.D. Okla. 1980) 15-10Veal v. Thomason, 138 Tex. 341, 159 S.W.2d 472, (1942) 15-73, 15-75W.A. Moncrief, Jr. v. U.S. Dept. of the Int., C87-1070 J (Wyo.) 15-24Waechter v. Amoco Production Co., 537 P.2d 228 (Kan. 1975) 15-61Wakefield v. State, 306 P.2d 305 (Okla. 1957) 15-74Ward v. Corporation Commission, 501 P.2d 503 (Okla. 1972) 15-45, 15-47, 15-81, 15-83Westland Oil Dev. Corp. v. Gulf Oil Corp., 637 S.W.2d...