FEDERAL GAS VALUATION REGULATIONS

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 2B
FEDERAL GAS VALUATION REGULATIONS¹
George W. Butler Senior Counsel
Chevron U.S.A. Production Company
Houston, Texas

Rocky Mountain Mineral Law Foundation

Special Institute on Federal & Indian Oil & Gas

Royalty Valuation and Management

Houston, Texas

February 2-4, 1998

I. Background/Introduction

The Federal Gas Valuation Negotiated Rulemaking Committee ("Committee"), established by Interior Secretary Bruce Babbitt on June 2, 1994,² arose from a Reinvention Laboratory Team initiated in response to Vice President Gore's National Performance Review.³ The Reinvention Laboratory Team recommended studying possible improvements to the gas valuation benchmarks, including the use of spot index prices.⁴ Consequently, the Royalty Management Advisory Committee of the Minerals Management Service (MMS) recommended that the gas valuation benchmarks be evaluated by a study team comprised of Federal lessees and the States. In December, 1993, MMS formed an informal study group to study not only the benchmark system and valuation of gas produced from Federal unit and communitization agreements.⁵

When establishing the Committee pursuant to the provisions of the Federal Advisory Committee Act⁶ and the Negotiated Rulemaking Act of 1990,⁷ Interior Secretary Bruce Babbitt stated:

[Page 2B-2]

Since the publication of the March 1, 1988, gas valuation regulations (30 CFR Part 206) many of MMS' constituents have expressed concern about the current "tracing method" of valuing production from unit and communitization agreements. ... Likewise, constituents have pointed out difficulties with the current benchmark system utilized to value non-arm's-length and no-sale situations. Those difficulties include issues of comparability, certainty, and access to information.⁸

* * *

[T]he criteria for negotiated rules, as spelled out in the Negotiated Rulemaking Act, are met for this rule:

• The rule is needed since royalty payors are not able to comply with the current regulations particularly in the current gas market.

• A limited number of identifiable interests will be significantly affected by the rule. Those parties are oil and gas companies who produce gas and pay royalties on Federal leases and States who receive royalties from gas produced from Federal leases located in their State.

• Representatives can be selected to adequately represent these interests, as reflected above.

• The interests are willing to negotiate in good faith to attempt to reach a consensus on a proposed rule.

• There is a reasonable likelihood that the Committee will reach consensus on a proposed rule within a reasonable time. This determination has been based on discussions of the study group, and hence is built on the developments to date.

• The use of the negotiation will not delay the development of the rule if time limits are placed on the negotiation. Indeed, its use will expedite both development and ultimate acceptance of the rule.⁹

The Committee's original Charter was to advise MMS on a rulemaking to address: (1) the valuation of gas produced from Federal unit and communitization agreements, and (2) the benchmark valuation system for valuing gas sold under non-arm's-length contracts.¹⁰ However, with MMS' concurrence the Committee Charter was expanded to include the valuation of Federal gas production under both arm's-length and non-arm's-length sales contracts.¹¹

[Page 2B-3]

Following the rules of the Negotiated Rulemaking Act, the Committee reached consensus¹² and published its Final Report in March, 1995. The Committee recommended: (1) valuation of gas sold under arm's-length contracts based on gross proceeds, or, in areas with an active spot market, based on published indices; (2) valuation of gas sold under non-arm's-length contracts based on published indices in areas with an active spot market, or based on a lessee's affiliate's gross proceeds; (3) valuation of natural gas liquids (NGL's) based on an index or residue gas price applied to a wellhead MMBtu; (4) entitlements reporting for mixed Federal unit and communitization agreements, with an exception for takes reporting for small independents; (5) distinct definitions of deductible transportation and non-deductible gathering costs; (6) distinctions between deductible and non-deductible compression costs; (7) elimination of transportation and processing allowance forms; and (8) elimination of dual accounting.¹³

On March 13, 1995, the Final Report was forwarded through the Associate Director for Policy and Management Improvement and the Associate Director for Royalty Management to MMS Director Cynthia Quarterman with a memorandum commending the negotiated rulemaking effort in the highest of terms.¹⁴ Concurrently, MMS initiated a public relations campaign in which Director Quarterman stated:

The proposed rule will simplify royalty payments on natural gas produced from Federal leases, while reducing regulatory burden and administrative costs, decreasing litigation, and maintaining revenue neutrality.

If you're a constituent not familiar with the Committee's deliberations, the report may appear to provide for a more complex regulatory structure. However, I believe you'll find its complexity does not result in additional regulatory burden, but instead provides regulatory relief through valuation options to meet the demands of this ever-changing natural gas market. The Committee's recommendations balance the needs of all types of producers who pay royalties, as well as the needs

[Page 2B-4]

of Federal and State Governments who are responsible for properly collecting and verifying those royalties.¹⁵

MMS published a notice of proposed rulemaking reflecting the consensus of the Committee ("Consensus Rule") on November 6, 1995.¹⁶ Then however, purportedly in response to "substantial comments" on the Consensus Rule, MMS reopened the comment period on May 21, 1996, suggesting 5 additional valuation options to the Consensus Rule,¹⁷ and it reconvened the Committee on June 12-14, 1996.¹⁸ On June 14, 1996, MMS declared that the Committee had failed to reach consensus, and that MMS would have to independently promulgate a rule.

On April 27, MMS published a notice withdrawing the Consensus Rule and requesting comments on 2 additional valuation options.¹⁹ In justifying the decision not to issue a final rule based on the consensus recommendations of the Committee, Director Quarterman stated:

1. The natural gas market is still undergoing dramatic change. ...

2. MMS believes that its existing regulations are very flexible and therefore are the most appropriate means to face the continued changes in the natural gas market.

3. MMS does not believe published indices for natural gas, representing spot prices at major pipeline interconnects, less transportation to the lease, have developed sufficiently to be representative of the gross proceeds actually received for lease production.

4. In the absence of published indices that accurately reflect market value, any rule using these indices would inevitably become complicated because of the requirement to compare them to gross proceeds. The comparison would have to take the form of some sort of safety net calculation, as in the proposed rule, or an adjustment to index based on the difference between index and gross proceeds. Analyzing and verifying gross proceeds data to accomplish these comparisons would place a significant burden on MMS.

5. The results of the MMS cost/benefit...