INDEPENDENTS — LARGE TO SMALL SAY YES TO RIK!
| Jurisdiction | United States |
(Feb 1998)
INDEPENDENTS — LARGE TO SMALL SAY YES TO RIK!
Independent Petroleum Association of America
Washington, D.C.
TABLE OF CONTENTS PAPER II. EXHIBIT 1 III. EXHIBIT 2 IV. EXHIBIT 3 V. EXHIBIT 4
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INTRODUCTION
Commencing with the 104th Congress, independent oil and gas producers began to voice their support of Royalty In-kind (RIK) as the preferred option to assure government certainty of a fair market value for federal production. Until MMS implements a complete RIK program, independents have been actively providing the agency recommendations on how to change its oil and gas valuation rulemakings. Extensive comments have been provided to MMS on how to best value oil production in a manner that is consistent with lease terms.1 Under the leasing statutes, it has long been settled that volumes of federal production are measured and valued at the lease.
Gross proceeds are no longer a certain and predictable method of valuing your production. With each rulemaking, MMS moves away from gross proceeds and looks downstream for cost-free added values. This approach will result in continued dispute. If MMS wants to enter into the downstream market, they should take their product in-kind. Some have falsely assumed that independents' involvement in this rulemaking process indicates that they are not committed to RIK. Nothing could be further from the truth. Independents want to operate under a valuation rule that is fair and reasonable until a national RIK program is implemented.
MMS' commitment to RIK is to pursue a federal policy to have a lessee market gas and oil on behalf of the government at no cost to the government. This "newly-minted duty to market" is strongly opposed by independents. It has been recently codified in MMS' recent rulemaking for transporting allowances related to gas production. This policy gives MMS a cost-free, risk-free "ride on the backs" of companies engaged in downstream activities. If MMS refuses to share in the risks and costs associated with downstream marketing then wellhead proceeds may no longer be acceptable. MMS could assess the wellhead producer for additional royalties based on the false assumption that the producer could bring in more revenues to the government by performing cost-free marketing.
CRONOLOGICAL HISTORY OF RIK
Independents began to pursue RIK during the passage of the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996. Originally, this law
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contained provisions that provided the Secretary of the Interior clear authority to take in-kind. This provision was supported by the independents.
Unfortunately, the RIK language was struck from the law under a procedural rule in the Senate concerning budget bills. Once stricken, the House Resources Committee chose to pursue RIK as separate legislation. IPAA supported this effort by testifying in a June 1996 hearing before the House of Representatives Subcommittee on Energy and Mineral Resources. Larry Nichols of Devon Energy, past chairman of IPAA's Land and Royalty Committee, states in his testimony that "When taken in-kind, market value is the price that the MMS receives from the willing purchasers" (Exhibit 1).
In 1997, independents continued to promote RIK by including the initiative in IPAA's legislative agenda. Many independents actively participated in a number of MMS RIK workshops this past spring. Suggestions were provided as to what were the pitfalls of an MMS test of an offshore gas RIK program and how a successful oil and gas RIK program could be designed. By taking oil in-kind, MMS will gain three benefits: 1) it will bring to an end its valuation controversies with lessees, 2) it will have a better basis to determine if the government is receiving fair market value, and 3) MMS will earn the higher rewards that the market holds for successful risk-takers.
The House Resources Committee restated its interest in RIK by holding a second hearing during the 105th Congress. Again, Larry Nichols testified on behalf of independents, and, on behalf of the entire industry. He unveiled industry agreement of principles for a successful RIK program. He made it clear that MMS must make a total commitment to RIK. Otherwise, no real cost savings can be realized (Exhibit 2).
Another IPAA member testified at this same hearing. Sue Hamm of Continental Resources (exhibit 3), brought to Congress' attention the success of a similar oil-RIK program in the Province of Alberta, Canada. In Alberta, 33 people run a royalty in-kind program which sells 146,000 barrels of oil per day. The MMS' royalty program employs approximately 1100 people to assure that the proper value is paid on about 205,000 barrels per day. The agency could dramatically reduce the size of its workforce and potentially increase its revenue.
After this hearing, opponents to RIK continued to question independents' commitment to RIK. The following is an excerpt from the Statement for the Record submitted on Sept. 18, 1997, by IPAA to document the current position of independents:
What is the Current Royalty System?
Whenever an oil or gas producer operates on federal land, it must pay the federal government a royalty for the oil or gas produced on that land.
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Currently, producers pay royalties based on a percentage of the value of their production. This is called paying royalty in-value. A producer receives a certain amount from a buyer and writes a royalty check to the government based on the sale price. But, the government often questions the value. Was it too low? Should the producer have marketed the oil or gas differently at no cost to the government? These are some of the uncertainties and second-guessing associated with this system.
What is Royalty In-Kind?
Taking a percentage of the actual oil or gas produced (i.e., taking an actual barrel of oil instead of a royalty check) is the best way to be sure that the federal government is getting its fair royalty amount. This is called paying royalty in-kind. By using this method, the federal government's concerns and perceived problems over valuing federal royalties could be fully addressed. As long as the Minerals Management Service (MMS) continues to take royalty in-value, as is the current practice, those concerns can never be fully resolved.
Why Do Independent Producers Want RIK?
A well-designed RIK program has significant potential to increase economic efficiency, maintain or increase federal and state revenues, reduce controversy, and be regarded as a fairer approach for the federal and state governments, lessees and the nation's taxpayers. For independent producers, RIK takes away the uncertainty involved with determining royalty values. It is the simplest and most certain way to avoid second-guessing by the government, which often leads to litigation, and to determine fair market value for federal royalties. RIK takes away the guesswork; it creates certainty.
How Has the Government Proposed to Fix the System?
The MMS has proposed a rule, which would value oil production, based on prices at the New York Mercantile Exchange (NYMEX). IPAA opposes this approach even though MMS has broadened its gross proceeds application. Even under the MMS' proposed changes, independents, large and small, will be subject to NYMEX. The NYMEX netback scheme will arrive at the wrong value for oil at the lease, never reflecting the value of real arms-length sales. The NYMEX netback scheme will be high one month, low the next and unpredictable throughout. That's simply unfair and doesn't reflect the true value of oil. IPAA believes that oil should be valued at the lease, based on the sale between a willing buyer and willing seller. Or, simply, that RIK should be used.
In its proposed regulations, MMS is wrongly attempting to value production by starting with a downstream price reflecting none of the operational costs producers face. If MMS proceeds with regulatory changes, other than royalty in-kind, independents have proposed alternatives (such as benchmarks) that resolve the debate in MMS' favor. MMS also is looking at alternatives to its NYMEX plan. IPAA hopes that these alternatives will first look to values received in the field.
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Will it be Better for Smaller Independents to Use RIK?
Definitely. It's true that some independents that sell at the wellhead will be allowed to pay royalties based on gross proceeds (the value of oil received at the wellhead) under the new proposed MMS regulations. However, MMS still restricts the application of gross proceeds in many scenarios, causing doubt and uncertainty when producers make a final royalty payment. MMS is also continuing to advance a scheme where these small producers must undertake downstream marketing risks free of cost to the government. This is called the "duty to market" requirement.
What is "Duty to Market?"
Through regulations, MMS wants the authority to require producers to market their oil at points where the government can have its royalty interest subsidized. So, instead of selling the oil at the wellhead, the producer would be forced to sell the oil at some point removed from the wellhead (downstream) at the government's insistence. MMS does not want to share in this added cost to producers, this "duty to market." It's a royalty subsidy. And it's another example of the government abusing its unlawful authority to engage in the business practices of small independent producers. These are the small producers who don't market their oil now. But under the MMS scenario, these producers would be forced to bear the expense of marketing under the "duty to market" requirement.
What about the Independents Who Already Market Their Oil?
MMS punishes independents that already market their oil. These companies will be forced to use the NYMEX netback scheme or...
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