FEDERAL AND INDIAN LEASE ROYALTY DECISIONS Important Judicial and Administrative Cases from 1992-1997

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 16A
FEDERAL AND INDIAN LEASE ROYALTY DECISIONS Important Judicial and Administrative Cases from 1992-1997
Howard W. Chalker
Office of the Solicitor
Department of the interior
Washington, D.C.
Geoffrey Heath
Sarah L. Inderbitzin
Office of the Solicitor
Department of the Interior
Washington, D.C.

TABLE OF CONTENTS

SYNOPSIS
Page

I. Marketable Condition/Gross Proceeds Cases

II. Other Gross Proceeds Cases

III. Gas Contract Settlements Cases

IV. "Restructured Accounting" Cases

V. Payor Liability Cases

VI. OCSLA "Citizen Suit" Cases

VII. Statute of Limitations Cases

VIII. Premature Appeals and Lawsuits Cases

IX. Affiliate Records Production Cases

X. Refund Withholding Cases

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This paper is intended to give a brief summary of many of the most significant administrative and judicial decisions on Federal and Indian oil and gas lease royalty issues issued since the 1992 Institute on Federal and Indian Oil and Gas Royalty Valuation and Management. The views expressed in this paper are the personal views of the authors and do not necessarily represent the views of the Office of the Solicitor, the Minerals Management Service (MMS), or the Department of the Interior (DOI). The cases are organized by functional category rather than separating administrative from judicial decisions, in the hope that the information will be more useful to the reader.

I. Marketable Condition/Gross Proceeds Cases

Oryx Energy Co. v. Department of the Interior, Civil No.92-C-1052 (N.D. Okla. 1996), appeal pending, No. 97-5051 (10th Cir.)

Oryx challenged a March 26, 1992 decision of the Assistant Secretary for Land and Minerals Management, affirming the MMS' assessment of royalties on certain reimbursements Oryx received from its purchaser under section 110(a) of the Natural Gas Policy Act (NGPA), 15 U.S.C. § 3320(a) , and the Federal Energy Regulatory Commission (FERC) Order 94 series for gas produced from a Federal offshore lease. The reimbursements were for the costs of moving gas to the pipeline purchaser at a point on the platform located on the lease where the gas was produced.

The court rejected Oryx' arguments that the movement of the gas constituted transportation (the costs of which would have been deductible) rather than gathering, which is necessary to put production into marketable condition.¹ The court followed the Fifth Circuit's decision in Mesa Operating Limited Partnership v. Department of the Interior, 931 F.2d 318 (5th Cir. 1991), cert. denied, 502 U.S. 1058 (1992), and applied the MMS' "marketable condition" rule to hold that the reimbursements were part of Oryx' royalty-bearing gross proceeds. The lessee's gross proceeds are the minimum value of production for royalty purposes.² The court therefore upheld the Assistant Secretary's decision. Oryx' appeal is pending.

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Amerada Hess Corp. v. Department of the Interior, Civil No. 94-C-1051 (N.D. Okla. 1997), appeal pending, No. 97-5223 (10th Cir.)

Amerada Hess challenged an MMS order, affirmed in an Assistant Secretary's decision dated December 1, 1995, assessing royalties on FERC Order 94 reimbursements Amerada Hess received for gas produced from several Federal offshore leases. The Assistant Secretary's decision analyzed each lease situation and found that the reimbursements paid were for gathering and were not for transportation. The court agreed in all respects and upheld the Assistant Secretary's decision.

The District Court also upheld MMS' regulation at 30 C.F.R. §§ 230.51 and 218.42 prohibiting "cross-lease offsetting" (except in certain narrowly defined circumstances not present in the case). The rules prohibit offsetting of overpayments on one lease against underpayments on another lease in determining the amount of an underpayment on which interest is owed or the amount of an overpayment for which a lessee must request a refund under an offshore lease. Amerada Hess' appeal is pending.

Beartooth Oil and Gas Co., 122 IBLA 267 (1992), vacated and remanded, Beartooth Oil and Gas Co. v. Lujan, No. CV 92-99 (D. Mont. 1993)

Beartooth produced gas from Federal leases in Utah and sold it at arm's length to Mesa Pipeline Co. (Mesa). Mesa compressed the gas and resold it to Mountain Fuel Resources, Inc. Mesa deducted the compression costs from the original price it paid to Beartooth and Beartooth paid royalties based on the reduced net sales price.

MMS assessed additional royalties for the period 1980 through 1986 because Beartooth deducted the compression costs from royalty value. MMS determined that the compression costs were costs of placing the gas into marketable condition. Such costs are not deductible from royalty value.³

Beartooth appealed the order first to the MMS Director, and then after an adverse decision to the Interior Board of Land Appeals (IBLA or Board). The IBLA agreed with MMS and held that a lessee cannot escape its obligation to place the gas into marketable condition at no costs to the Federal lessor by paying a third party to compress the gas and then deducting the costs from royalty value.⁴

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Beartooth sought judicial review of the IBLA's decision in the District of Montana. The court vacated the IBLA's decision and remanded the case to the IBLA. The court stated that MMS' regulations define "marketable condition" as a condition in which the gas would be accepted by a purchaser under a sales contract typical for the field or area. 30 C.F.R. § 206.151 . The court found that the IBLA did not consider whether the Beartooth-Mesa sales contract was typical for the field or area. Further, the court concluded that the IBLA erred by failing to determine if the compression costs were for transportation. The parties later settled this case.

Xeno, Inc., 134 IBLA 172 (1995), action for judicial review dismissed, Xeno, Inc. v. Babbitt, No. CV-95-142 (D. Mont. 1997), appeal pending, No. 97-35517 (9th Cir.)

During the period January 1982 through December 1986, Xeno produced gas from 12 Federal oil and gas leases in Montana. The leases were part of a much larger field containing more than 100 leases. Xeno transferred the gas to Battle Creek Gas Gathering System, a joint venture owned by Xeno and some of the other working interest owners in the field. Xeno owned about 11 percent of Battle Creek and had limited voting authority for another 14 percent interest in Battle Creek.

Xeno transferred the gas to Battle Creek at the wellheads. Battle Creek moved the gas downstream and compressed it. At the tailgate of its compressor, Battle Creek sold the gas to Montana Power for a price higher than it paid to Xeno. The MMS Director affirmed an assessment of additional royalties on the ground that Xeno could not use its sale to Battle Creek to deduct the costs of gathering and compression. On this basis, the Director held that royalty value was the price paid by Montana Power to Battle Creek after the gas had been gathered and compressed.

Xeno appealed the MMS Director's decision to the IBLA under 30 C.F.R. § 290.7. At the IBLA, MMS maintained that the sale from Battle Creek to Montana Power, minus transportation costs, reflected the actual gross proceeds.

The IBLA vacated and remanded the MMS Director's decision. Among several conclusions important to royalty valuation, the Board held:

[T]he sale price received by an affiliate of the lessee in the first arm's-length sale is properly considered in determining the value of gas produced under the gross proceeds rule. Shell Oil Co. (On Reconsideration), 132 IBLA 354 (1995), overruling Shell Oil Co., 130 IBLA 93 (1994); see, Santa Fe Energy Products Co., 127 IBLA 265 (1993). It appears that there was an economic benefit to the lessee from formation of the joint venture [Battle Creek] to undertake delivery of the gas to Montana Power.

134 IBLA at 179. The Board also held that it was not precluded from considering the gross proceeds rule, even though the MMS Director did not rely on it. Id. at 179 n.11.

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The Board also noted that there was a market for unprocessed gas at the wellheads, created by more than one purchaser with competing offers. Further, the wellhead pressure was adequate to gain direct access to the pipeline market. Consequently, under the particular circumstances of this case, the compressor was not required to place gas in marketable condition. As a result, in this case, the Board treated the cost of the compressor as a transportation cost. Id. at 184. The IBLA remanded the case to MMS to determine the appropriate transportation allowance.

Xeno sought judicial review of the IBLA's decision. The court granted the United States' motion to dismiss for failure to exhaust administrative remedies. Under the IBLA's remand, MMS is in the process of determining the appropriate transportation allowance, which will affect the amount of royalties owed. Thus, the Department has not issued its final decision subject to judicial review. Xeno's appeal of the District Court's dismissal is pending in the Ninth Circuit.

Texaco Inc., 134 IBLA 109 (1995), affirmed, Texaco, Inc. v. Quarterman, No. 96-CV-08 (D. Wyo. 1997)

Texaco sold its sour gas production to CIG. The sales contract stated that the price for the gas would be adjusted downward to compensate CIG for removing impurities to "sweeten" (remove the sulfur from) its "sour" gas (i.e., gas with a high sulfur content). Texaco argued that the royalties were not due because the sale to CIG established that there is a market for sour gas. The IBLA upheld MMS' assessment of royalties on the grounds that Texaco improperly excluded its purchaser's costs to sweeten the gas from royalty value, in violation of the marketable condition rule.

The court upheld the IBLA's decision, finding no "clear error of judgment" in the IBLA's finding that sour gas is not in marketable condition. The court stated...