CHAPTER 4 CURRENT MMS ROYALTY VALUATION ISSUES AND TRENDS
| Jurisdiction | United States |
(May 1989)
CURRENT MMS ROYALTY VALUATION ISSUES AND TRENDS
LISKOW & LEWIS
New Orleans, Louisiana
I. Introduction.
This paper discusses the Minerals Management Service's ("MMS") 1988 royalty valuation guidelines and amendments, beginning with a history of the federal government's royalty collection efforts and ending with an analysis of various aspects of the MMS' new gas royalty valuation regulations.1 It also addresses other significant royalty related issues, including jurisdiction over appeals from final decisions of the Department of the Interior and the limitations period on royalty refund
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claims imposed in Section 10 of the Outer Continental Shelf Lands Act ("OCSLA").2
II. Historical overview.
The Minerals Management Service ("MMS") was established as a sub-agency of the United States Department of the Interior by a Secretarial Order issued in January 1982.3 Simultaneously, the Conservation Division of the United States Geological Survey ("USGS") — another agency of the Department of the Interior — was abolished, and all of its functions were transferred to the newly created MMS. Included among these functions was the responsibility for collecting mineral revenues from federal and Indian lands and disbursing those revenues either to the federal treasury, to certain onshore states because of their entitlement to a portion of the revenues generated from federal lands within their jurisdictions, or to Indian lessors, depending on the nature of the lands involved.4
Initially, the Interior Department's Bureau of Mines was responsible for collecting and disbursing these revenues, but in 1925, the Conservation Division was created, and all mineral revenue functions were transferred to it.5 Although the Conservation Division was able to handle its mineral revenue responsibilities well during the first three decades of federal
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leasing,6 its problems began to increase tremendously with the exponential increase in mineral revenues that occurred when the offshore areas were opened to federal leasing by the OCSLA in the early 1950's. During the ten years from 1951 to 1960, for example, royalty revenues, exclusive of bonuses, grew to $757 million, more than double what collections had been during the preceding thirty years.7
During the next ten years, from 1961 to 1970, revenues from the same sources more than tripled, jumping to $2.5 billion.8 Then, from 1971 to 1980, revenues jumped to $12.1 billion, almost five times the amount collected during the preceding ten years.9 Revenues for the current decade are projected to be approximately $51.9 billion.10 In fact, revenues for the first five years of the decade amounted to $24 billion, already almost twice what collections had been during the immediately preceding ten years.11
This tremendous increase in revenues simply overwhelmed the Conservation Division, which had remained decentralized and somewhat understaffed throughout the period.12 Consequently, by the end of 1979, major staff expansion and management reform was planned and budgeted. These changes were hardly underway, however, when national attention was focused on the federal minerals management program because of serious allegations that were being raised by the Shoshone and Arapahoe tribes on the Wind River Reservation of oil theft, fraud and underpayments of royalties under oil and gas leases administered by the USGS.13 As a result of these allegations, the then Secretary of the Interior,
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James Watt, chartered an investigative panel. This panel, formally entitled the Commission on Fiscal Accountability of the Nation's Energy Resources, was more popularly known as the Linowes Commission, after its chairman, David Linowes. The Linowes Commission's report was published in January 1982, and was critical of the federal minerals management program.14
The basic message of the report was that greater accountability was needed with respect to minerals management.15 Essentially, the Linowes Commission recommended a complete overhaul of the minerals management program, and it made some sixty specific recommendations dealing with such issues as site security, the government's lax enforcement practices, the need for the government to audit and reconcile royalty accounts, and the lack of cooperation between the federal government and the states and Indian tribes.16 The report also criticized the lack of certainty in the agency's valuation guidelines, but only made a general recommendation that the agency needed to act promptly to clarify those guidelines.17 In the midst of the public attention that was being focused on the minerals management program as a result of the allegations of improper management and the Linowes Commission's investigation, two significant events occurred. First, Congress passed the Federal Oil & Gas Royalty Management Act ("FOGMRA") in 1982.18 The FOGRMA provided the Secretary of the Interior with expanded authority to collect information, to audit federal leases, and to enforce royalty collections through the imposition of penalties. Second, the MMS was created in 1982 to "improve the management of and provide greater management oversight and accountability for the minerals related activities previously carried out by the Conservation Division of the Geological Survey."19
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III. Organizational structure of the MMS.
The Director of the MMS reports to the Assistant Secretary for Land and Minerals Management who in turn is directly responsible to the Secretary and Undersecretary of the Department of the Interior.20 The MMS has four regional offices, one of which covers the Alaska OCS region, one the Gulf of Mexico OCS region, one the Atlantic OCS region, and one the Pacific OCS region. In addition, the Minerals Management Service operates the Royalty Management Program ("RMP") headquartered in Lakewood, Colorado.21 The purpose of the RMP, as expressed in its mission statement, is
In accordance with law, to assure proper determination, collection, and distribution of bonuses, rents, and royalties from Federal and Indian lands in a manner that minimizes disincentives to the efficient management, production, and utilization of oil, gas, coal, and other mineral resources, consistent with public health and safety, environment, and public land use requirements.22
These functions are currently carried out through a staff of more than 600 federal employees and 150 contract personnel, working primarily from the Denver office.23
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IV. History of the oil and gas product valuation regulations.
Because the current regulatory scheme is in many ways a continuation of previous regulations and policies, it is helpful to have some background regarding prior regulatory developments. As already indicated, the Linowes Commission recommended increased auditing by the Department of the Interior. As a result, a number of audits were conducted by the Department of Interior's Office of Inspector General ("OIG"), which found that the most substantial problem was not intentional or fraudulent under-reporting but simply a lack of clear guidance on valuation issues.24
The first step in the MMS' clarification of the regulatory framework was an advance notice of proposed rulemaking published in 1986.25 In that notice, the MMS sought public comment on five separate draft regulations relating to product valuation for coal, oil, gas and associated products, processing allowances, and transportation allowances. Those proposals and recommendations were reviewed by the Royalty Management Advisory Committee ("RMAC"), created by Interior Secretary Donald Hodel, which consisted of thirty-one members from various states and Indian tribes, as well as from the oil and gas industry and the general public.26
After review by the RMAC and other interested parties, the MMS, at Congress' insistence,27 published further notices of
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proposed rulemaking regarding oil product valuation28 and gas product valuation.29 These notices were followed by second notices of proposed rulemaking for oil and gas product valuation.30 In response to various comments received on the second notices, third notices were published as well.31 Final rules, effective March 1, 1988, were ultimately published on January 15, 1988.32 Subsequently, technical corrections were issued to both the oil and gas valuation regulations.33 In addition, in response to certain jurisprudential developments discussed more fully below, the MMS retroactively amended the definition of the term "gross proceeds" in the regulations.34
Although the regulations were published on January 15, 1989, they were final for purposes of judicial review on the previous day, and on that day, January 14, 1989, ANR Production Co. v. Hodel,35 was filed in the Western District of Louisiana to challenge the validity of the regulations. The plaintiffs in that suit are primarily oil and gas producers which are affiliated with the purchasers of production.
In the first count of their complaint, the plaintiffs are challenging the allegedly discriminatory treatment of contracts that do not qualify under the regulations as "arm's length contracts."36 In the second count, the plaintiffs are challenging the inclusion of payments that allegedly are not
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payments for the sale of "production" within the meaning of that term as found in the "gross proceeds" definition.37 In the third count, the complaint challenges the treatment of sales under percentage-of-proceeds ("POP") contracts as sales of processed gas on the ground that even though these contracts provide for payment based on a percentage of the amount the purchaser receives from processing the gas, they are in fact sales of unprocessed gas, which usually occur at the wellhead.38
In their fourth count, the plaintiffs are challenging the failure of the MMS to allow...
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