FERC JURISDICTIONAL ISSUES RELATED TO ROYALTY VALUATION — FEDERAL OFFSHORE ROYALTY IMPLICATIONS

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management III
(2000)
CHAPTER 13C
FERC JURISDICTIONAL ISSUES RELATED TO ROYALTY VALUATION — FEDERAL OFFSHORE ROYALTY IMPLICATIONS
Deborah Bahn Haglund
Haglund Law Firm
Dallas, Texas

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Introduction

Federal offshore leases typically provide that royalties are to be paid based on the value of the production saved, removed, or sold from the leased premises.¹ This means that if offshore production is sold away from the lease, the lessee's downstream sales proceeds must be location-adjusted so that the lessee pays royalties only on the value of the production at the lease.² Under MMS' current regulations, a lessee makes this adjustment by deducting a transportation allowance from its downstream sales proceeds to arrive at the value on which royalties are due.³

If the lessee has an arm's length transportation contract, the price paid under the contract generally is the amount that is deductible as the lessee's transportation allowance.⁴ In the absence of an arm's length transportation contract, the lessee must use an actual cost formula prescribed by MMS to determine the amount that it can deduct as its transportation allowance.⁵ For gas allowances and for oil allowances until MMS' new oil valuation regulations become effective, the lessee may request an exception from MMS' actual cost formula requirement if a tariff for the transportation system has been approved by FERC or a State regulatory agency.⁶

Since MMS bears a portion of a lessee's arm's length transportation expense through the allowance of a transportation deduction, MMS has an interest in assuring that the amount paid by the lessee under its arm's length transportation contract is not excessive. MMS therefore has an interest in FERC's exercise of its jurisdiction to determine just and reasonable transportation rates by approving tariffs under the Interstate Commerce Act (ICA) (for oil) and the Natural Gas Act (NGA) (for gas). For the same reason, MMS has an interest in FERC's exercise of its jurisdiction under the Outer Continental Shelf Lands Act (OCSLA) to ensure that oil and gas is transported on an open and nondiscriminatory basis through offshore pipeline facilities.

FERC jurisdictional issues also are relevant in the non-arm's length transportation context. To the extent that MMS regulations expressly allow FERC-approved tariffs to be used as the lessee's

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non-arm's length transportation allowance, MMS has an interest in FERC's exercise of its jurisdiction under the ICA and NGA to approve those tariffs.

Finally, FERC jurisdictional issues are relevant in situations where MMS elects to take the government's royalty share in amount (i.e., in kind) rather than in value (i.e., in cash). Most offshore leases provide for the delivery of royalty-in-kind production (RIK) on or immediately adjacent to the leased premises. If MMS requires the lessee to deliver RIK downstream of that point, it must reimburse the lessee for the transportation costs incurred in doing so.

MMS regulations implementing the Small Refiners RIK program specifically provide for the reimbursement of downstream transportation costs incurred by the lessee.⁷ Under this program, the reimbursement is to be based on "the reasonable cost of transportation ... in an amount not to exceed the transportation allowance determined pursuant to 30 CFR part 206."⁸ FERC jurisdictional issues thus are relevant in the Small Refiners RIK program to the same extent that they are relevant in determining transportation allowances for royalties paid in value under 30 C.F.R. part 206. MMS also is conducting RIK pilots pursuant to which MMS or its purchasers will be accepting delivery of the RIK production on or immediately adjacent to the offshore lease. MMS and its purchasers under the pilots will be impacted by the rates charged since they will be shippers of the RIK production.

To agree that FERC jurisdictional issues impact MMS, however, is not necessarily to agree that MMS' positions regarding those jurisdictional issues are correct. Sometimes, MMS' positions do not even agree with one another. For example, MMS has asserted that it supports a more "lighthanded" regulatory approach to ratemaking by FERC, yet at the same time it is asking FERC to require OCS pipelines to supply more information than even FERC is proposing, detailed cost information whose only purpose appears to be to allow MMS to engage in its own form of ratemaking.

This paper will examine the various assertions by MMS regarding FERC jurisdictional issues. It appears from this examination that MMS's ultimate goal may not be to see FERC replace its existing scheme of rate regulation with a more "light-handed" regulatory approach, but rather to see FERC's existing scheme of rate regulation be replaced with rate regulation by MMS.

MMS Comments in FERC Docket No. RM99-5-000

In a Notice of Proposed Rulemaking (NOPR) issued on June 30, 1999,⁹ FERC requested public comment on a proposal to issue new regulations pursuant to FERC's authority under the OCSLA to ensure that natural gas is transported on an open and nondiscriminatory basis through pipeline facilities located on the Outer Continental Shelf.¹⁰ Specifically, FERC is proposing a new rule to

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require "gas service providers"¹¹ to file reports detailing (1) their corporate structure and affiliations and (2) the conditions, including rates, under which they are providing offshore transportation services.

The OCSLA authorizes FERC to exempt any pipeline "which feeds into a facility where oil and gas are first collected or a facility where oil and gas are first separated, dehydrated, or otherwise processed" from the statute's open access requirements.¹² FERC is proposing to exercise its authority under this provision to exempt from the proposed reporting requirements "services rendered over facilities that feed into a facility where natural gas is first collected, separated, dehydrated, or otherwise processed."¹³ FERC also is proposing to exempt from the proposed reporting requirements any gas service provider

• that serves only a single entity (either the gas service provider itself or a third party) or

• that serves only shippers having an ownership interest in both the transporting pipeline and the gas produced from the field connected to the pipeline.¹⁴

Under the NOPR, these exceptions would terminate if the gas service provider offers to serve another shipper or if FERC determines that the gas service provider's denial of a request for service by another shipper is unjustified and the shipper denied service contests the denial.¹⁵

MMS filed comments in Docket No. RM99-5-000. In its comments, MMS argues that:

FERC should adopt the proposed reporting requirements, since to do so will further the goals of the OCSLA,

FERC should jettison its own definitions of transportation and gathering and adopt MMS' definitions of those terms,

FERC should not adopt the proposed exceptions to the reporting requirements, but rather it should subject all offshore gas service providers to those requirements, and

FERC should require gas service providers to file a complete description of their costs, as defined in MMS' transportation allowance regulations, whenever that those costs are the "charges" incurred by the provider or the...