ROYALTY VALUATION PROCEDURES
| Jurisdiction | United States |
(Jan 1992)
ROYALTY VALUATION PROCEDURES
Office of the Solicitor Department of the Interior
Washington, D.C.
TABLE OF CONTENTS
Introduction
I. The Secretary of the Interior's Authority To Determine Royalty Value
A. Federal Onshore Leasing Statutes
B. Offshore Leasing Statutes
C. Indian Leasing Statutes
D. Lease Terms
E. Regulations
1. Regulations Applicable to Federal and Indian Oil and Gas Leases Prior to March 1, 1988
a. Federal Onshore Leases
b. Indian Leases
c. Federal Offshore Leases
2. Regulations Applicable To Federal and Indian Oil and Gas Leases After March 1, 1988
3. Regulations for Onshore Federal Coal Leases Prior to March 1, 1989
4. Regulations Applicable to Federal and Indian Coal Leases After March 1, 1989
F. The Standard and Scope of Judicial Review of the Secretary's Royalty Valuation Determinations Are Limited
II. MMS' Application of the Secretary's Valuation Authority
A. In General
B. Limitations on MMS' Discretion in Establishing Royalty Value
1. Specific Commitment to a Valuation Procedure for Production from a Lease
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a. Royalty Payment Procedure Letters and Other Directives
b. Regulations and Interpretations Thereof
2. Valuation Determinations In Excess of Statutory Authority or Inconsistent with Longstanding Statutory Interpretations
C. The Lessee's Burden to Demonstrate Error
Conclusion
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Introduction
Pursuant to his authority under various mineral leasing laws, the Secretary of the Interior administers more than 24,000 producing leases for oil, gas, coal, geothermal steam, and other mineral resources. These leases underlie Federal lands, the Outer Continental Shelf, and Indian tribal and allotted lands. All of these leases require payment to the lessor of a royalty on the production removed from the lease. One of the Secretary's primary responsibilities is to ensure that those royalties are paid properly. See, e.g., section 101 of the Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA), 30 U.S.C. 1711.
The producing leases generate over 250,000 report lines of royalty data each month. Obviously, with such an extensive lease universe, it is impossible for the Minerals Management Service (MMS) to review the propriety of royalty payments every month. MMS therefore necessarily relies on an audit and enforcement program that reviews royalty payments previously made to determine the extent of compliance. This paper will review the bases of, and the limitations on, the authority to establish royalty value in the exercise of the Secretary's royalty management responsibility.
I. The Secretary of the Interior's Authority To Determine Royalty Value
The various mineral leasing statutes and lease terms consistently have been construed as vesting in the Secretary considerable discretion to establish the value of production for royalty purposes for federal and Indian leases. Marathon Oil Co. v. United States, 604 Supp. 1375 (D. Alaska 1985), aff'd., 807 F.2d 759 (9th Cir. 1986), cert. denied, 480 U.S. 940 (1987); Jicarilla Apache Tribe v. Supron Energy Corp., 782 F.2d 855 (10th Cir. 1986), cert. denied, 479 U.S. 970 (1986); California Oil Co. v. Udall, 296 F.2d 384 (D.C. Cir. 1961); Continental Oil Co. v. United States, 184 F.2d 802 (9th Cir. 1950); United States v. Ohio Oil Co., 163 F.2d 633 (10th Cir. 1947), cert. denied, 333 U.S. 833 (1948). Recently, Judge Walter in the Western District of Louisiana upheld a DOI royalty order, stating:
It is well established that the Secretary of the Interior has the authority and considerable discretion to establish royalty values of production from federal oil and gas leases.
Amoco Production Co. v. Hodel, Civil No. 87-0243 (W.D. La.), Memorandum Ruling dated October 3, 1988, at 7.
A. Federal Onshore Leasing Statutes
The Mineral Leasing Act (MLA), 30 U.S.C. 181 et seq., authorizes the Secretary of the Interior to issue oil and gas leases on
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public domain lands.1 The lessee must pay a royalty of "not less than 12-1/2 per centum in amount or value of the production removed or sold from the lease." 30 U.S.C. 226 (emphasis added). The Secretary also is vested with authority to issue regulations to implement the statute. The MLA provides:
The Secretary of the Interior is authorized to prescribe necessary and proper rules and regulations and to do any and all things necessary to carry out and accomplish the purposes of this chapter....
30 U.S.C. 189.
The MLA also authorizes the leasing of coal on public domain lands. 30 U.S.C. 207.2 The Federal Coal Leasing Amendments Act of 1976 (FCLAA), Pub. L. No. 94-377, amended 30 U.S.C. 207 to require a royalty based on the "value of coal as defined by regulation."3 This provision applies to coal leases issued after FCLAA, as well as to leases that are "readjusted" at their initial 20-year anniversary date following FCLAA's enactment. See, FMC Wyoming Corp. v. Hodel, 816 F.2d 496 (10th Cir. 1987), cert. denied, 484 U.S. 1041 (1988); Colowyo Coal Co. v. Lujan, 895 F.2d 780 (D.C. Cir.), cert. denied, 111 S.Ct. 48 (1990).
B. Offshore Leasing Statutes
The Outer Continental Shelf Lands Act (OCSLA) was enacted in 1953 to give the Secretary of the Interior authority to issue oil and gas leases for tracts on the federal Outer Continental Shelf (OCS), control over which had then recently been confirmed in the United States. Section 5(a) of the OCSLA, 43 U.S.C. 1334(a), provides the Secretary with the statutory authority to issue and
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manage leases on the OCS. Section 8 of the 1953 Act required royalties to be set as follows:
at the discretion of the Secretary, on the basis of a cash bonus with a royalty fixed by the Secretary at not less than 12 1/2 per centum in amount or value of the production saved, removed or sold....
43 U.S.C. 1337 (1976) (emphasis added). In 1978, section 8 was amended to provide the Secretary the discretion to offer leases using alternate bidding systems, but those amendments reaffirmed that royalties are still to be calculated on the "amount or value of the production saved, removed or sold." 43 U.S.C. 1337(a) (1979). The OCSLA further vests in the Secretary of the Interior the authority and responsibility to "prescribe such rules and regulations as may be necessary to carry out such provisions [of the Act]." 43 U.S.C. 1334(a). The OCSLA does not further define the phrase "value of the production saved, removed or sold" but leaves that determination to the Secretary in the exercise of his rulemaking authority.
C. Indian Leasing Statutes
For Indian tribal lands, 25 U.S.C. 396a authorizes the Secretary to issue leases for oil, gas, coal, and other minerals. The terms for such leases, including royalty terms, are not prescribed in the statute, but are left by Congress to the discretion of the Secretary. Specifically, 25 U.S.C. 396d provides:
All operations under any oil, gas, or other mineral lease issued pursuant to the terms of sections 396a to 396g of this title or any other Act affecting restricted Indian lands shall be subject to the rules and regulations promulgated by the Secretary of the Interior.
The Secretary was granted similar authority for mineral leases issued on allotted Indian lands. 25 U.S.C. 396.
D. Lease Terms
Additionally, the Secretary's authority and discretion to determine the value for royalty purposes of production from federal and Indian leases is found in the terms of the lease itself. The typical onshore federal oil and gas lease form contains an express agreement reserving to the Secretary the authority to determine value:
It is expressly agreed that the Secretary of the Interior may establish reasonable minimum
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values for purposes of computing royalty....
Sample federal onshore oil and gas lease at section 2(d)(2). Furthermore, the introduction to those leases provides that the lease is "subject to all rules and regulations of the Secretary of the Interior now or hereafter in force....which are made a part hereof." Id. at Introduction (emphasis added). Similarly, the standard Indian tribal and allotted leases provide that the lessee agrees:
To abide by and conform to any and all regulations of the Secretary of the Interior now or hereafter in force relative to such leases....
Sample Oil and Gas Mining Lease — Tribal Indian Lands, at section 3(g).
The standard federal offshore lease contains similar language in regard to royalty valuation:
It is expressly agreed that the Secretary may establish minimum values for purposes of computing royalty on products obtained from this lease....
Also, the introductory clause of the standard offshore lease states:
This lease is subject to all the provisions of the Act and to all the terms, conditions and requirements of the valid regulations promulgated by the Secretary of the Interior....
Therefore, offshore, onshore and Indian lessees have expressly agreed that their leases are subject to the Secretary's rules for determining royalty value.
E. Regulations
1. Regulations Applicable to Federal and Indian Oil and Gas Leases Prior to March 1, 1988
a. Federal Onshore Leases
Prior to MMS's promulgation of comprehensive new product value regulations for oil and gas (see 53 Fed. Reg. 1184 and 1230 (Jan. 15, 1988)), the general oil and gas valuation rules were codified at 30 C.F.R. 206.103 (1987), originally promulgated in identical form as 30 C.F.R. 221.47 almost fifty years ago. 7 Fed. Reg. 4132
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(June 2, 1942). These regulations left considerable discretion to the agency to determine royalty value:4
The value of production, for the purpose of computing royalty, shall be the estimated reasonable value of the product as determined by the Associate Director due consideration being given to the highest price paid...
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