PROPOSED FEDERAL CRUDE OIL VALUATION REGULATIONS — INDUSTRY PERSPECTIVE
| Jurisdiction | United States |
(Feb 1998)
PROPOSED FEDERAL CRUDE OIL VALUATION REGULATIONS — INDUSTRY PERSPECTIVE
Jackson & Kelly
Washington, D.C.
Part IV.C Industry Perspectives
Like my co-authors, who have written the prior 30-odd pages from a governmental perspective without per se speaking for their employers, I do not speak for the industry in this portion of the paper. But I am well-acquainted with industry positions on the issues raised by the proposed crude oil valuation rules and will offer personal perspectives.
Convinced that posted prices no longer reflect fair market value, MMS has floated a series of proposals which it hopes will better reflect market value while reducing the administrative costs of royalty valuation. Oil and gas lessees either are supportive of, or at least indifferent to, all three of these fundamental points and goals. Specifically, industry is generally indifferent to MMS's desire to decrease reliance on posted prices. Indeed, some trade associations have proposed that MMS eliminate reliance on posted prices. Industry supports changes in the royalty program to assure that the federal lessor is receiving fair market value for its royalty share of the oil. Furthermore, industry enthusiastically supports reducing the administrative costs of the royalty valuation program.
Despite all this agreement, trade associations are not docilely placing flowers in the muzzles of MMS's rifles. Why not? I am reminded of a song by John Lennon. Sing along with me. "All we are saaaay-ing/ Is give royalty-in-kind a chaaaaance."
Having MMS take its royalty share of crude oil in kind — as it currently does for approximately 40 percent of all barrels of royalty oil — will eliminate reliance on posted prices. It will eliminate controversies over oil valuation. It will guarantee that MMS is receiving fair market value for crude oil. It will, far more than any other proposal on the table, reduce administrative costs. Its just like the rental car business. There's royalty-in-kind, and then there's "not exactly."
The rest of this part of the paper is an embellishment on two themes pertinent not to royalty-in-kind, but to MMS's proposed rule on royalty valuation. First, MMS may decrease its reliance on posted prices, but it needs to maintain its reliance on market prices from sales of crude oil at the lease. Just because some parties are frustrated (or bored) by the manner in which MMS has enforced the current rules does not mean that the rules themselves are unsound. Second, MMS should not be startled by the apparent revelation its auditors have received that crude oil sold at market centers or futures contracts sold on the New York Mercantile Exchange often command a higher price than that stated in price postings for oil delivered at the lease. Movement of crude oil from the lease to a market center (with its other attendant "midstream" activities) adds value to the oil, sometimes significantly more value than it cost to transport the oil. But sometimes value is not added. Whether value is added or not, the difference in value is attributable to the risks and costs
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undertaken by those operating in the midstream market. It is not attributable to the value of production at the lease.
1. Value at the Lease
Industry's general view is that MMS's proposed rule has gone far beyond the Department's longstanding approach to valuation. It may be helpful to recall what that approach has been. The Department of the Interior issues and administers oil and gas leases under the Outer Continental Shelf Lands Act, 43 U.S.C. §§ 1331 et seq., the Mineral Leasing Act, 30 U.S.C. §§ 181 et seq., and the Acquired Lands Leasing Act, 30 U.S.C. §§ 351 et seq. For the purpose of this rulemaking, the Department's authority under each is essentially the same. The Secretary is to issue leases while reserving a royalty of a given percentage of the amount or value of oil produced and removed or sold from the lease.
For royalty purposes, value "means 'reasonable market value'; that price which a product will bring in an open market, between a willing seller and a willing buyer." United States v. General Petroleum Corp., 73 F. Supp. 225, 235 (S.D. Cal. 1947), aff'd sub nom. Continental Oil Co. v. United States, 184 F.2d 802 (9th Cir. 1950). See also California Co. v. Udall, 296 F.2d 384, 387 (D.C. Cir. 1961) ("value" under Mineral Leasing Act means "fair market value"). Cf. NRDC v. Hodel, 865 F.2d 288, 312 (D.C. Cir. 1988) (approving Secretary's "willing buyer and willing seller" test for fair market value in the sale of leases); Amoco Production Co. v. Hodel, 877 F.2d 1243, 1245 (5th Cir. 1989), cert. denied, 493 U.S. 1002 (1989) (applying this fair market value test to oil and gas royalties).
Under the leasing statutes, it has long been settled that volumes of production are measured and valued at the wellhead on the lease. General Petroleum Corp., 73 F. Supp. at 254 ("royalties are payable on the gas as it is produced at the well"); Mobil Producing Texas & New Mexico, Inc., 115 IBLA 164, 171 (1990) ("normally gas is sold and valued for royalty purposes at the wellhead"). Even the Department's most attenuated method of valuing royalty, which values certain natural gas from Alaska's Kenai Peninsula by starting with the first sale's price in Japan and netting out the costs of transportation and liquefaction, is nothing more than an attempt in a "special, unique situation" to "arrive at a reasonable wellhead value." Marathon Oil Co. v. United States, 604 F. Supp. 1375, 1385 (D. Alaska 1985), aff'd, 807 F.2d 759 (9th Cir. 1986), cert. denied, 480 U.S. 940 (1987). This measurement and valuation historically has occurred at the "point of royalty computation" located ordinarily "at the wellhead" or within the "lease ... boundary." (Conservation Division Manual, Part 647, chapter 1, p. 3.) Though the point of royalty computation is now called the "point of royalty settlement," 30 C.F.R. § 206.103(a)(1) , its location remains unchanged. 43 C.F.R. § 3162.7-2 (onshore) and 30 C.F.R. § 250.180 (offshore).
Of course, it is not always possible for the producer to sell production at the lease. Whenever that situation arises, the Department values the royalty share by looking to the first sale of the production, then granting a reduction from that price for the cost of transporting it from the lease to the point of sale. But the Department's willingness to grant
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transportation allowances cannot obscure the fact that the Department has looked to the market nearest the lease as the proper place to begin royalty valuation. Although the Department grants transportation allowances "where there is no market in the field," id., "transportation costs have been disallowed where the costs claimed were for transportation beyond the point of the nearest potential market." ARCO Oil and Gas Co., 109 IBLA 34, 38 (1989). Superior Oil Co., 12 IBLA 212 (1973), is the best known illustration of the principle. There the lessee sought an allowance to transport oil beyond the point of the first potential market, Burns Terminal in Louisiana. The Department denied an allowance transportation costs incurred beyond Burns. See also Kerr-McGee Corp., 22 IBLA 124, 127-28 (1975) (approving allowance because lessee sought an allowance for transportation only to "the point of the first market," distinguishing Superior Oil). In sum, the Department has found in the past that the market nearest the lease provides the best information about the value of oil at the lease.1
That is certainly the approach Congress intended. The policy of Congress has been to create a federal lease consistent with "the terms of leases which have been developed and are in general use in the industry after a long period of trial and error...." H.R. Rep. No. 2078, 81st Cong., 2d Sess. 9-10 (1950) (OCS Lands Act). See Amoco Production Co. v. Andrus, 527 F. Supp. 790 (E.D. La. 1981) (rejecting agency interpretation of leasing statute as inconsistent with longstanding industry and agency practice); Marathon Oil Co. v. Andrus, 452 F. Supp. 548 (D. Wyo. 1978) (same). All states of which we are aware value royalty at the wellhead or on the lease. See, e.g., Heritage Resources, Inc. v. Nationsbank, 939 S.W.2d 118, 122 (Tex. 1996); Babin v. First Energy Corp., 1997 WL 155022 (La. App. 1997); Piney Woods Country Life School v. Shell Oil Co., 539 F. Supp. 957, 971 (S.D. Miss. 1982), aff'd in relevant part, 726 F.2d 225 (5th Cir. 1984), cert. denied, 471 U.S. 1005 (1985); Hurinenko v. Chevron U.S.A., Inc., 69 F.3d 283 (8th Cir. 1995) (applying North Dakota law); Vedder Petroleum Corp. Ltd. v. Lambert Lands Co., 50 Cal. App.2d 102, 122 P.2d 600 (1942). Consistent with this approach, Congress expressly limited MMS's power to compel royalty recordkeeping to information through the later of "the point of first sale or point of royalty computation...." 30 U.S.C. § 1713(a).
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Accordingly, until now, MMS has looked to prices received at the lease or in the field. Prior to the 1988 oil value rules, the agency looked to prices paid "in the field" and to "posted prices," which under industry practice were listings of prices buyers were offering to purchase crude oil at locations in the fields specified in the posting. 30 C.F.R. § 206.103 (1987). The 1988 rules, while more specific, reaffirm the policy of accepting the lessee's proceeds under arm's-length sales agreements, 30 C.F.R. § 206.102(b)(1)(i) ; and when the sales were not at arm's length, the lessee in almost all cases is to look to contemporaneous posted prices or oil sales contract prices used in arm's-length transactions in the same field. 30 C.F.R. § 206.102(c) .
MMS's proposal at least still recognizes the concept of valuing production using information from the lease market, because it acknowledges "the presence of true arm's-length...
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