INDIAN GAS VALUATION: A NEW RULE WITH HISTORICAL PERSPECTIVE

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 5A
INDIAN GAS VALUATION: A NEW RULE WITH HISTORICAL PERSPECTIVE


Donald T. Sant
Richard J. Adamski
Royalty Management Division Minerals Management Service
Denver, Colorado

Table of Contents

SYNOPSIS

I. Introduction

II. Background

III. Indian Gas Valuation Study Group

IV. Negotiated Rulemaking Act of 1990

V. Indian Gas Valuation Negotiated Rulemaking Committee

VI. Amendments to Gas Valuation Regulations for Indian Leases; Proposed Rule

A. Background

B. Value of Gas Produced from Leases in an Index Zone

1. Dedicated Contracts

2. Safety Net Price

C. Value of Gas Production When an Index-based Method Cannot Be Used

1. Major Portion Calculation

2. Minimum Value for Gas Plant Products

D. Dual Accounting

E. Contract Settlements

VII. Benefit/Cost Analysis

A. Comparison of Current to Proposed Valuation

VIII. Conclusion

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I. Introduction

The Secretary of the Interior (Secretary) is obligated to act as a fiduciary in the administration of Indian oil and gas leases.¹ As a fiduciary, charged with supervising the disposition of nonrenewable resources from Indian lands, the Secretary must ensure that Indians receive the maximum revenues from mineral resources on their lands. To ensure maximum revenues, the value of production for royalty purposes from an Indian lease should be determined considering the highest values provided by the terms of the Indian lease. The Minerals Management Service (MMS) believes this is consistent with the terms of Indian oil and gas leases, with statutes delegating to the Secretary the administration of Indian affairs, with the statutes governing Indian oil and gas leases, with the Federal Oil and Gas Royalty Management Act of 1982, with court decisions providing judicial guidance in the interpretation and administration of Indian oil and gas leases, and with the law of trusts and fiduciary operations.

II. Background

Since the publication of the March 1, 1988, gas valuation regulations, many of MMS's constituents have expressed concern about the valuation basis for Indian gas royalties. Concern has focused upon the scope of the Secretary's discretion to determine the values of lease substances for royalty purposes in a manner consistent with the Federal trust responsibility to Indian beneficiaries. Extension of principles established in the Jicarilla v. Supron decision requires that the Secretary take every reasonable step in valuation determinations to maximize

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Indian royalty revenue.² Moreover, the implementation of specific valuation methodologies contained in the standard OIL AND GAS MINING LEASE—TRIBAL AND ALLOTTED INDIAN LANDS paragraph 3(c) Rental and royalty, such as dual accounting, and major portion analysis, has been problematic. Those difficulties include issues of comparability, certainty, and access to information.

Part of MMS's proactive approach enforcing Indian lease terms has been to issue "Dear Payor" letters. A Dear Payor letter dated September 30, 1988, reemphasized to payors their obligation to properly determine and pay royalties on production from Indian leases. On July 27, 1992, MMS issued a Dear Payor letter to assist payors in timely complying with their royalty obligations and to assure the Indian lessor timely receipt of the monies which they are due. In this letter, MMS developed a theoretical method of accounting for comparison³ that payors used to approximate the value of gas after processing. On February 2, 1993, MMS issued another Dear Payor letter again reemphasizing the payor's obligation to properly determine and pay royalties on gas production from Indian leases and to offer assistance in overcoming difficulties in fulfilling the dual accounting obligation. To verify that companies had complied with the dual accounting requirements of Indian leases, MMS issued a Dear Payor letter dated September 29, 1995, requiring companies to declare their level of compliance.

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III. Indian Gas Valuation Study Group

In 1993, in response to Vice President Gore's National Performance Review (NPR), the Royalty Management Program (RMP) initiated a Reinvention Laboratory Team to examine ways to streamline the royalty management process. One of the overall recommendations of the NPR Team was to improve the gas valuation process on Indian lands. In commenting on the recommendations of the NPR Team, the Royalty Management Advisory Committee recommended that MMS sponsor an effort to improve and refine Indian gas valuation policy, including new valuation regulations, considering the unique lease terms in Indian leases.

In January 1994, MMS formed the Indian Gas Valuation Study Group (Study Group). MMS met during the winter and spring of 1994 with representatives of several Tribes and allottee associations to receive input about the current gas market and identify regulatory changes needed to add certainty and simplicity to valuation, for royalty purposes, of gas produced from Indian leases.

Members of the study group included representatives involving from time to time the Navajo Nation, the Jicarilla Apache Tribe, the Native American Rights Fund, the Shoshone and Arapaho Tribes of the Wind River Reservation, the Northern Ute Tribe, the Southern Ute Tribe, the Council of Energy Resource Tribes, the Bureau of Indian Affairs (BIA), and MMS.

An informal study group format was used to obtain and clarify varying viewpoints. Because much of the study group's early work centered around the construction of Indian lease terms, the study group needed time to independently develop its own collective understanding of the Indian valuation issues. Industry was not represented on the team but information was actively solicited from several knowledgeable guest speakers from industry. The study group met eight times and developed strategies involving major portion valuation, dual accounting, and percentage-of-proceeds

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contracts. The group reviewed in detail the terms of standard Indian leases, current enforcement practices, available alternatives to existing practices, and potential for implementation of alternatives. Some Indian leases or agreements negotiated under the 1982 Indian Mineral Development Act contain explicit methodologies for determining royalty obligations. MMS did not alter these express valuation methodologies. The study group's initial work culminated in the publication of an Advance Notice of Proposed Rulemaking (ANOPR), on August 4, 1994, soliciting comments on new methodologies being considered to establish value on production from Indian leases. MMS received comments from 13 entities on the ANOPR.

IV. Negotiated Rulemaking Act of 1990⁴

MMS and the study group participants believed that the input sessions were mutually beneficial but that now it was time to add new members representing large, medium, and small oil and gas operators. As a result, MMS thought it appropriate for the study group to transform itself and make specific regulatory recommendations for implementing a rulemaking regarding Indian gas valuation. The Department of the Interior (DOI) therefore proceeded to establish the Indian Gas Valuation Negotiated Rulemaking Committee (Committee). The study group's discussions also enabled MMS to determine that the criteria for negotiated rules as spelled out in the Negotiated Rulemaking Act, are met for this rule:

• The rule is needed, because royalty payors have considerable difficulty in complying with the current regulations at the time royalties are due, particularly in the...