FEDERAL OIL VALUATION: WHERE ARE WE NOW?
| Jurisdiction | United States |
(Feb 2004)
FEDERAL OIL VALUATION: WHERE ARE WE NOW?
Onshore Compliance - Minerals Management Service
Denver, Colorado
I. Introduction
The Minerals Management Service (MMS) published the final Federal oil valuation rulemaking on March 31, 2000, with an effective date of June 1, 2000 - meaning that the rule applies to all crude oil produced from Federal leases starting on June 1, 2000. In his paper "Where Have We Been?" my co-author, David Deal, summarizes key aspects of the June 2000 rule. Further detail on the operational aspects of the rule can also be found in my paper from the April 2000, Special Institute on Royalty Valuation and Management III, Paper No. 14A.
Section II of this paper will focus first on the MMS's experience in implementing the June 2000 rule including the judicial challenge to the rule, requests for valuation determinations under the rule, future valuation agreements, and what MMS has learned from taking oil royalties in kind in the Gulf of Mexico and in Wyoming. Following that discussion, Section III will turn to MMS's efforts in 2003 to seek public input as to whether or not we got it right in June 2000 or whether we needed to make refinements to the rule. Section IV summarizes the August 20, 2003, proposed rulemaking including a side-by-side comparison with the June 2000 rule. As of the due date for this paper, MMS had not yet published a final rulemaking. As such, Section V can only provide a summary of the comments received on the August 20, 2003, proposed rulemaking. If MMS publishes the final rule before February 11, 2003, I will provide a summary during my oral presentation at the Special Institute. 1
II. Life After June 2000
A. Judicial Challenge
Immediately following the publication of the June 2000 final rule, the producing industry filed a lawsuit challenging several of the provisions of the rule (Independent Petroleum Association of America v. Baca, Civil No. 00-761 (RCL) (D.D.C.), and American Petroleum Institute v. Baca, Civil No. 00-887 (RCL) (D.D.C.) (consolidated). API and IPAA challenged the following provisions of the rule:
1. Duty to market
2. Downstream indices
a. Rejection of comparable arm's-length prices in favor of indexing
b. Rejection of tendering except in very limited form
c. Failure to adopt adequate quality and location adjustments
d. Application of West Texas Intermediate (WTI) at Cushing for Rocky Mountain Region production
e. Application of Alaska North Slope (ANS) spot prices for California production
f. One-month lag in applying index prices
3. Transportation allowances
a. Rejection of Federal Energy Regulatory Agency (FERC) tariffs
b. Adoption of BBB bond rate
4. Affiliate resales
5. Allegedly tainted rulemaking process
6. Buydown Payments
Plaintiffs advised the Court that the rulemaking, if it goes final, may lead to resolution of many of the issues in the litigation. They asked the Court to hold the case in abeyance until the rule is completed. By Orders dated November 21, 2003, the Court dismissed these cases without prejudice subject to reinstatement and reactivation of the procedural status quo upon proper motion. On December 4, 2003, the firm of Lobel, Novins & Lamont, filed a motion on behalf of California State Controller Steve Westly to reinstate the case for the purpose of permitting his intervention under Rule 24 of the Federal Rules of Civil Procedure.
B. Requests for Value Determinations
One of the issues of debate during the development of the June 2000 rulemaking was binding value determinations. In its February 1998 supplementary proposed rulemaking, MMS had proposed at 30 CFR 206.107 that lessees may ask MMS for valuation guidance or propose a valuation method to MMS and that MMS will promptly review the proposal and provide the requestor with a nonbinding determination. During the rulemaking process, industry representatives expressed concern that the number of requests for value determinations would increase dramatically because of what they perceived as the complexity of the new rule. Therefore, they argued for binding value determinations that would provide them with certainty as to how to properly value their Federal oil production.
In the final rule, in response to comments, MMS provided for a procedure for value determinations that is more than simply non-binding guidance. Under § 206.107 of the final rule, lessees may request a value determination from MMS regarding any Federal lease oil production. In response, MMS may either:
(1) Issue a value determination signed by the Assistant Secretary, Land and Minerals Management; or
(2) Issue a value determination by MMS; or
(3) Decline to provide a value determination.
A value determination signed by the Assistant Secretary, Land and Minerals Management, is binding on both the lessee and MMS until the Assistant Secretary modifies or rescinds it. It is also the final action of the Department and is subject to judicial review under the Administrative Procedure Act, 5 U.S.C. 701-706 . In contrast, a value determination issued by MMS is binding on MMS and delegated States with respect to the specific situation addressed in the determination, unless the MMS or the Assistant Secretary modifies or rescinds it.
In actual practice, MMS has not received a large number of requests for value determinations under the June 2000 Federal oil valuation rule. The requests we have received fall into the following categories:
• tendering program in the Rocky Mountain Region (2)
• approval of valuation method for oil not sold under tendering in the Rocky Mountain Region
• valuation for oil placed in inventory and later sold
• use of posted price bulletin schedule to adjust index price for quality differences
• approval of gravity and sulfur adjustments for oil sold non-arm's length
• use of index price without a location/quality adjustment instead of tracing
• determination of whether the relationship with a pipeline is at arm's length
• clarification of "Four Corners" area
• allowability of stabilizer costs
• use of weighted average of arm's-length sales in lieu of index
• approval to use weighted average costing of transportation allowance
• guidance on non-arm's-length transportation and pipeline depreciation
• use of location differential based on different production areas in North Dakota
• guidance on quality bank adjustments
C. Future Valuation Agreements
In the June 2000 final rule, MMS added a separate provision at new § 206.100(d) (3). That provision states that if a written agreement between the lessee and the MMS Director establishes a production valuation method for any lease that MMS expects at least would approximate the value otherwise established under the MMS regulations, the written agreement will govern to the extent of any inconsistency with the regulations. This provision is intended to provide flexibility to both MMS and the lessee in those few unusual circumstances where a separate written agreement is reached, while at the same time maintaining the integrity of the regulations. As noted, any such agreement also must at least approximate the royalty value that would apply under the regulations for the production.
MMS has entered into only a few future valuation agreements under the June 2000 oil rule. Generally, those agreements have been to accommodate the unique accounting, marketing, or system arrangements of the lessee. In evaluating the requests for future valuation agreements, MMS and the States involved have had an opportunity to better understand the marketing practices of these lessees. Because of the requirement that the value under any such agreement at least approximate the value otherwise established under the rule, the agreements that we do have generally require an annual "true-up" mechanism to compare the value under the agreement with the value that would have been calculated under the rule. In some cases, the agreements contain thresholds within which the lessee and MMS agreed that the lessee would not make prior period payments or adjustments.
D. What We Learned from Taking our Oil in Kind in Wyoming and in the Gulf of Mexico
The MMS's Royalty-In-Kind (RIK) pilot programs over the past several years have provided valuable commercial insights into crude oil transportation, marketing, and sales. Some observations with implications for royalty in value regulations include: 2
• Pricing Methodologies: The majority of Gulf of Mexico (GOM) crude oil producers, aggregators, traders, and refiners buy and sell crude oil based on a Koch Posting basis adjusted for the "P±" factor. (Note that the P± factor reflects the price of WTI sold into Cushing on the basis of "postings plus." P-plus deals are invoiced at a later date on the basis of a differential to an average of one or more crude oil postings. For example, a deal done at P-plus 75 cents would be invoiced at 75 sets more than the previously agreed-upon posting basis.) 3
An additional prominent methodology, though less widely used, is the "Calendar Month NYMEX" methodology (with and without the "roll" factor). (Note that the "roll" is a commonly used measure of the trend of NYMEX prices for future deliveries in those areas.)
Purchases/sales based on Platts market center assessments are relatively rare in comparison.
Long-term pricing data for GOM crude indicate that both the Koch P± and Calendar Month NYMEX methodologies maximize returns relative to other potential pricing methodologies.
• Wyoming Pricing Methodologies: Producers, aggregators, traders, and refiners use a wide variety of pricing mechanisms, focusing on baskets...
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