THE BUREAU OF LAND MANAGEMENT'S AUTHORITY TO GRANT ROYALTY RELIEF

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management Book 1
(Feb 2004)
CHAPTER 7A
THE BUREAU OF LAND MANAGEMENT'S AUTHORITY TO GRANT ROYALTY RELIEF
Lonny Bagley ¹
Bureau of Land Management (Washington Office)
Billings, Montana

I. Introduction

Under section 39 of the Mineral Leasing Act (30 U.S.C. § 209), Bureau of Land Management (hereinafter "BLM") has operated a variety of programs designed to reduce royalties due on certain Federal mineral leases in an effort to promote the greatest ultimate recovery of natural resources, to conserve those resources, and to allow marginal producers to successfully operate their leaseholds. ² These programs have made available royalty rate reductions for federal mineral lessees/operators who would otherwise be unable to successfully operate their mineral recovery operations. ³ BLM's programs have also provided royalty rate reductions for the operators of both low production oil wells and heavy oil (low gravity crude) wells, based on their properties' particular characteristics. ⁴

These production incentives, however, may change dramatically should Congress enact legislation such as the proposed comprehensive Energy Policy Act considered in 2003. ⁵ That legislation proposed to create a broad marginal property production incentive program that would reduce the royalties due from marginal producers of gas as well as oil under Federal oil and gas leases. Specifically, the Act proposed to create a new royalty reduction program for low production oil properties to better protect the economic interests of the United States while being easier to administer. The Act also proposed, for the first time, to bring natural gas properties into BLM's rate reduction programs, with the creation of a rate reduction program for marginally producing gas wells.

Although the legislation has been stalled because of disagreement on other aspects of the legislation, the discussion draft released by House and Senate conferees last fall gives an indication of Congressional interest in modifying the forms of royalty relief currently available. Such provisions may yet be included in any energy legislation that may be enacted in this Congress. ⁶ This paper examines how those provisions would impact future royalty rate reduction programs, and compare how the reduction programs proposed in this Congress differ from the programs BLM has in place today.

II. Background

Section 39 of the Mineral Leasing Act of 1920, codified at 30 U.S.C. § 209, authorizes the Secretary of the Interior (hereinafter "Secretary") to "waive, suspend, or reduce the rental, or minimum royalty, or reduce the royalty on an entire leasehold, or on any tract or portion thereof segregated for royalty purposes" normally due on mineral leases

• to encourage "the greatest ultimate recovery of coal, oil, gas, oil shale, gilsonite (including all vein-type solid hydrocarbons), phosphate, sodium, potassium and sulphur;" and

• "in the interest of conservation of natural resources;"

upon the Secretary's determination that either

• "such an action is necessary to promote development;" or

• "an existing mineral lease could not otherwise be successfully operated" under its lease terms. ⁷

III. Current Regulations

The BLM, through the Secretary, is authorized to "waive, suspend or reduce the rental or minimum royalty or reduce the royalty on an entire leasehold, or any portion thereof" when it determines that such an act is necessary to promote the development of the leasehold, or when a lease could not otherwise be "successfully operated" under its existing terms. ⁸ Just as in the Mineral Leasing Act, this authorization is intended to "encourage the greatest ultimate recovery of oil or gas," while conserving mineral resources and avoiding the premature abandonment of otherwise recoverable reserves. ⁹ Pursuant to this congressional grant of authority, BLM has promulgated regulations that set out the conditions under which holders of federal mineral leases may qualify for royalty rate reductions. These BLM regulations provide for royalty relief, upon application when a federal mineral lease cannot be "successfully operated" under the existing lease terms, ¹⁰ or simply by notification when extraction from a low production well falls below a certain threshold, ¹¹ or when a heavy oil well produces crude oil with a 'weighted average gravity' below a certain degree. ¹²

A. § 3103.4-1: Royalty Rate Reductions out of Necessity

The first royalty relief program created by Congress in the Mineral Leasing Act, partly in an "effort to reduce the regulatory burden imposed on those who apply to lease the public lands for oil and gas operations," was the royalty rate reduction program based on necessity. ¹³ This program was designed for the purpose of, and continues to, allow both oil and gas resource extractors operating under Federal leases to reduce the rate of royalty due to the federal government, when such a reduction is 'necessary' either to promote development, or to make the lessee's extraction operation economically feasible. ¹⁴ Specifically, when BLM makes a determination that a reduction in royalty "is necessary to promote development," or that a lease cannot otherwise "be successfully operated under the terms provided therein," BLM "may waive, suspend or reduce the rental or minimum royalty or reduce the royalty on an entire leasehold, or any portion thereof." ¹⁵ In order to receive a reduced royalty under this program, Federal lessees must apply to BLM and provide certain specific information having to do with their extraction operations. ¹⁶ BLM then uses this information to decide whether or not it will grant a royalty rate reduction, as well as the size of the reduction, in light of its statutory mandate to grant royalty reductions only when economically necessary to allow an operator to 'break even' financially, ¹⁷ or when economically necessary to promote the development of a mineral resource. ¹⁸

B. § 3103.4-2: The Stripper Well Royalty Rate Reduction Program

In 1992, the BLM created the stripper well royalty rate reduction program. This program, made specifically for the operators of low production oil wells, or 'stripper wells,' was created "in order to encourage operators of Federal stripper oil properties to place marginal or currently uneconomical shut-in oil wells back in production and to provide the economic incentive to increase production by reworking such wells, drilling new wells, and/or by implementing enhanced oil recovery projects." ¹⁹ It defines such a well as one that produces an average of less than 15 barrels of oil per well per day in a given period. ²⁰ The average production of all oil wells located on a particular property is used to determine if that property will qualify as a "stripper well property." ²¹ This program permits an operator or payor to reduce the royalty percentage due the government, calculated according to a pre-determined formula contained within BLM's regulations. ²² Generally, this formula provides that a lessee's royalty rate (as a percentage of the value of resources extracted) shall be reduced to an amount equal to one-half of one percent plus 8/10ths times the "average daily production rate" ²³ of the property over the previous 12 months (rounded down to the next whole number). ²⁴ Once the operator of a stripper well property determines that its property is eligible for the rate reduction, the operator must notify the Minerals Management Service and, using Form MMS-4347, submit its calculation of the reduced royalty rate. ²⁵

Every 12 month period of production after the initial period in which a lessee receives a rate reduction under this program, the operator must go through the same process to determine its new average production rate for the property, which is then imputed into the same royalty rate calculation formula to determine the percentage of royalty due on the next 12 month period. ²⁶ Subsection (iii)(B) of the regulation provides that if any subsequent 12 month period of production, after the initial qualifying period, reveals a different average daily production rate, the lower of the two rates shall be used in determining the percentage of royalty to be paid for the current 12-month period. Further, subsection (iii)(C) provides that, should the average daily production rate increase for any 12 month period, the new royalty percentage due shall never exceed the original "calculated qualifying royalty rate," as it was determined in the first year the property qualified for this rate reduction, for the life of the program. ²⁷ The effect of this provision is to assure an operator its original "calculated qualifying royalty rate" under the program, regardless of whether the property increases production at a later time, even to such a level that it would no longer fit the definition of a stripper well. By this means, BLM seeks to encourage well reworking or other efforts to increase the productivity of marginal properties.

Properties that do not qualify for the royalty rate reduction after their first 12 month production period, or that do not initially fit the definition of a 'stripper well' under the program, are given the opportunity to use any subsequent 12 month production period to qualify for the reduction. The first 12 month production period in which such a property does qualify for the rate reduction then becomes the baseline for determining its "qualifying royalty rate," using that period's average daily production rate. ²⁸ As with properties that qualify for the rate reduction in their initial 12 month period of production, this later "qualifying royalty rate" serves as the maximum royalty of which the property can be assessed throughout the life of the program, despite any increases in production that may occur at a later date. ²⁹

However, at all times throughout the program, the royalty rate can never fall below the minimum...