PROPOSED FEDERAL CRUDE OIL VALUATION REGULATIONS
| Jurisdiction | United States |
(Feb 1998)
PROPOSED FEDERAL CRUDE OIL VALUATION REGULATIONS
Department of Natural Resources
State of Louisiana
Richardson, Texas
Deborah Gibbs Tschudy
Royalty Valuation Division
Minerals Management Service
Denver, Colorado
TABLE OF CONTENTS
I. Valuation and Auditing of Oil in the Context of Major Market Transitions Occurring Over the Last 25 Years
A. World Events Causing Oil Valuation Changes and Regulatory Responses in That Era—State Perspective
B. Auditing Challenges Caused by Oil Valuation Changes and Regulatory Responses—State Perspective
C. Development of the Spot Market—MMS Perspective
II. Why MMS and the States Are Considering Revisions to the Regulations
A. MMS Perspective
B. State Perspective
III. MMS's Proposed Rulemaking
A. January 24, 1997, Proposed Rulemaking
B. July 3, 1997, Supplementary Proposed Rulemaking
C. Summary of Comments on January 24, 1997, Proposed Rules and July 3, 1997, Supplementary Proposed Rule
D. September 22, 1997, Reopening of Public Comment Period
E. Comments Received After the September 22, 1997, Federal Register Notice
IV. MMS, State, and Industry Perspectives
A. MMS Perspective
B. State Perspective
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I. Valuation and Auditing of Oil in the Context of Major Market Transitions Occurring Over the Last 25 Years
Someone once said that to understand and appreciate the present, we should learn about the past.
The focus of this portion of the paper is to give an overview to "issues" surrounding oil valuation leading up to the present "great debate" concerning oil valuation. By studying the past, we may find areas of similarities to today's disputes, and other problems that make current areas of disagreement seem like a piece of cake in comparison.
I would first like to look at the late 60's to mid 80's politics, regional disputes in that era, regulatory responses, and audit valuation problems springing from all of the above.
A. World Events Causing Oil Valuation Changes and Regulatory Responses in That Era — State Perspective
In the 1960's, oil was thought to be a cheap and abundant source of energy for the foreseeable future. Indeed many studies done in the 60's do not even mention possible oil shortages or potential run ups in price that could negatively affect the economies of industrialized nations and less developed nations.1 What these studies did not take into account, however, was the rising tide of nationalism present or soon to be present in the oil exporting countries of the Middle East. Up until the late 1960's, the Organization of Producing Export Countries (OPEC) had not exercised any market clout. Political developments in the Middle East were soon to cause what can only be described as revolutionary change in the way the majority of the world's oil was priced and marketed.
Arab countries were frustrated by their lack of control over production and pricing of oil removed from their lands. That is why, that during the Six Day Arab Israeli war in 1967, oil was not used as a political weapon.2 Actions taken over the next six years by the Middle Eastern countries would institute a new paradigm of control over production. The Gulf nation states would have the economic power to act decisively, when in their opinion, forceful actions were called for.
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In 1970, the price posted by producers for Saudi light marker crude hit an all time low of $1.21/bbl.3 This fact is important to note as most Middle east countries participated in profit sharing arrangement with their concessionaires or simply levied large excise taxes against production value. Value was determined by applying posted price to units of production.4
OPEC countries widely distrusted the posted prices used by the producers. In research for this article, this is the first occasion I came across whereby posted price was challenged as not representing value. Due to the fact that OPEC countries received income based on transfer pricing, and the transfer price was based on postings, they sought out means to increase posted prices.
Initially, their arguments were that the U.S. dollar (in which they were paid) was declining in value and that inflation was eating away at the purchasing power of the monies they received. Armed with these arguments, they entered into "negotiations" with producers.5
Eventually, stronger actions were taken by other Gulf States. "Negotiations" began on nationalizing foreign concessions in the producing countries. A partial listing of nationalizations includes Algeria — French oil concessions in 1971, Libya — BP concession in 1971, Iraq—BP, Royal Dutch Shell, Compagnie Francaise, Mobil, Esso, & Chevron, Iran—Esso, Chevron, Socony-Vacuum, Texaco, Gulf and Royal Dutch Shell, Libya — Bunker Hunt concession, 51 percent of Oxy concession, and Algeria — "acquiring" 35 percent of Shell/BP concession.6 Many more nationalizations than these listed took place.
Through the "voluntary" negotiation process and later through the efforts of nationalization, posted prices for benchmark Middle Eastern crudes ranged from $2/bbl to about $3/bbl during the 1971 to
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the early 1973 period.7 It is interesting that although the world price of oil was in this range, U.S. domestic prices were over $1/bbl higher, due to the continued existence and enforcement of crude oil import quotas started in the Eisenhower administration.8
Now that the question of what the posted price should be and who controls the posted price was answered (rather arbitrarily by political means, and implicitly, by military means), the stage was set for the most rapid rise of price in history for the one resource the world could not get along without.
In the United States (U.S.), we were in a period of price controls, both "voluntary" and mandatory. On August 19, 1973, President Nixon's Cost of Living Council (CLC) issued regulations, effective September 1, freezing oil prices at May 1973 postings plus $.35.9 The regulations created categories, such as new and released oil (production from a property in a month in excess of production from the same property in the corresponding 1972 month) which could rise to market prices. Production from stripper wells was also allowed to be sold at market levels. Also, in 1973, the mandatory oil import program was abolished.10
CLC's authority was delegated to the Federal Energy Office (FEO) in January 1974.11
Meanwhile, back in the Middle East, in late 1973, events were now occurring which directly affected the explosive run up in oil prices. The Arab/Israeli war broke out on October 6. Middle Eastern countries, now in control of oil produced in their region, decided to use oil, over which they now controlled the means of production, as a "political weapon" for the first time.
Production cuts were instituted by the Gulf Six; Saudi Arabia, Kuwait, Abu Dhabi, Iran, Iraq, and Qatar on October 16. This action was soon followed by an announcement to embargo countries, including the U.S., who were friendly with Israel. On November 5, production was cut again, this time by 25 percent, so that embargoed countries could not simply effectuate swaps with non-embargoed countries to secure supplies of crude. The producers of 70 percent of the world's noncommunist oil had reduced their output, and correspondingly had reduced world output, by about 17.5 percent.12
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OPEC recognized the increased demand for a suddenly scarce product and raised posted prices, over which they now held complete control, to $11.65/bbl from $5.12/bbl on December 22, 1973. In 1974, after the end of the Arab Israeli war, OPEC withdrew the embargo against the U.S. and most of the other embargoed countries. For the rest of 1974 through the end of 1978, world prices remained relatively stable, ranging from $11/bbl to about $15/bbl. No major transitions occurred during this period, but 1979 would mark the beginning of another massive restructuring of prices, political instability, and U.S. regulatory responses.
During this 1974-78 period, the U.S. regulatory responses to escalating oil prices were confused at best. Conflicting U.S. policy goals of protecting U.S. consumers from high energy prices while at the same time providing incentives for domestic producers resulted in a hodgepodge of nightmarish regulations. One example of confusion over the regulations is that "property" (the basis for comparison of current production to base period production to determine new" oil content) was never satisfactorily defined in the first round of regulation writing. It was not until August of 1976 that property was defined in terms consistent with general industry practice.13
Significant changes occurred in regard to the initial CLC regulations and the agencies charged with enforcing those and subsequent regulations. As noted earlier, FEO took over authority from CLC in January 1974 and soon issued its own regulations almost identical to CLC's.14 The Federal Energy agency was created in June 1974 with the authority to administer pricing and allocation regulations.15 Later, DOE and two of its subordinate agencies, Economics Regulatory Administration (ERA) and Federal Energy Regulatory Commission (FERC), would have various responsibilities over regulation writing and enforcement. (See below.)
The Emergency Petroleum Allocation Act of 1973 was amended in December 1975. Among other things it provided for an escalating price for lower tier and upper tier oil. Forty months after its implementation in February 1976, price controls would end after May 1979. However, the President of the U.S. was given discretionary authority to extend them through September 1981.16
DOE was created on October 1, 1977. Within DOE, the ERA was given authority to administer it's regulatory programs in regard to existing regulations and to propose new regulations in the future...
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