THE NEW INDIAN GAS VALUATION RULE

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management III
(2000)
CHAPTER 3A
THE NEW INDIAN GAS VALUATION RULE
Theresa Walsh Bayani
Royalty Valuation Division Minerals Management Service
Denver, Colorado

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TABLE OF CONTENTS

SYNOPSIS

I. Introduction

II. Background

III. How Does the Lessee Value Gas Production In an Index Zone?

What Leases the Index-Based Valuation Method Applies

Valuing Residue Gas and Gas Before Processing

Valuing Gas That is Processed Before It Flows Into a Pipeline with an Index

Determining the Index-Based Value for Gas Production

Determining the "Safety Net Price"

Exclusion From an Index Zone

IV. How Does the Lessee Calculate the Alternative Methodology for Dual Accounting?

Electing a Dual Accounting Method

How Does the Lessee Calculate Value Using the Alternative Methodology for Dual Accounting?

V. How Does the Lessee Value Gas Production Not Sold From an Index Zone?

Situations In Which an Index-Based Method Cannot Be Used

How Is the Major Portion Value Calculated For Non-Index Zones?

Valuing Gas Production Under Arm's-Length Contracts

Valuing Gas Production Under Non-Arm's-Length Contracts

Minimum Value of Production

Marketable Condition/Marketing

Time Limits On Adjustments and Audits For Indian Leases In Montana and North Dakota

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VI. When and How Does the Lessee Perform Dual Accounting?

VII. What New Requirements Regarding Transportation Allowances Apply To the Lessee?

General Transportation Allowance Requirements

Determining a Transportation Allowance Under an Arm's-Length Contract

Determining a Transportation Allowance Under a Non-Arm's-Length Contract or No Contract

How and When Does the Lessee Elect to Use the Alternative Transportation Allowance Calculation?

Reporting Transportation Allowances

VIII. What New Requirements Regarding Processing Allowances Apply To the Lessee?

General Processing Allowance Requirements

Determining a Processing Allowance Under an Arm's-Length Contract

Determining A Processing Allowance Under a Non-Arm's-Length Contract or No Contract

Reporting Processing Allowances

IX. How Does the Lessee Establish Processing Costs For Dual Accounting Purposes When the Lessee Does Not Process the Gas?

X. How Does the Lessee Determine the Volume of Production to Pay Royalty If the Lease Is Not In an AFA?

XI. How Does the Lessee Determine How Much Royalty to Pay If the Lease Is In an AFA?

XII. Conclusion

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I. Introduction

This paper provides a brief background and discussion of the new regulations governing the valuation for royalty purposes of natural gas produced from Indian leases. The new Indian gas rule, effective January 1, 2000, applies to all gas production from Indian (tribal and allotted) oil and gas leases (except leases on the Osage Indian Reservation). The new regulations resulted from a negotiated rulemaking between Indian representatives, oil and gas industry, and Government.

The paper highlights how lessees¹ will determine the value of gas produced from an index zone or not produced from an index zone (non-index zone). The Minerals Management Service (MMS) defines an index zone as a field² or area³ with an active spot market⁴ and published indices applicable to that field or area that are acceptable to MMS. In addition, this paper addresses the safety net calculation for an index zone; the options for electing either actual accounting for comparison (dual accounting) or alternative methodology for dual accounting (alternative dual accounting); the new requirements for transportation and processing allowances; and how the lessee determines the value of production when the lease is in an approved Federal unit or communitization agreement (AFA).⁵

If the specific provisions of any Federal statute, treaty, negotiated agreement, settlement agreement resulting from any administrative or judicial proceeding, or Indian oil and gas lease

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are inconsistent with any part of this regulation, then the Federal statute, treaty, negotiated agreement, settlement agreement, or lease will govern to the extent of that inconsistency.

II. Background

On August 10, 1999, MMS amended the regulations governing the valuation of natural gas produced from Indian leases (64 FR 43506). These amendments add alternative valuation methods to the March 1, 1988, valuation regulations to ensure that Indian lessors receive maximum revenues from their natural gas production and to improve the accuracy of royalty payments at the time royalties are due. The new rule will be easier to implement because data will be more readily available. In addition, the rule accomplishes the major portion and dual accounting provisions of the Indian lease terms in a more contemporaneous manner.

The framework for the rule was the product of an Indian Gas Valuation Negotiated Rulemaking Committee (Committee). On January 31, 1995, the Secretary chartered the Committee to develop specific recommendations with respect to the valuation of gas production from Indian leases (60 FR 7152, February 7, 1995). Members of the Committee included MMS, industry, and Indian representatives. All of the Committee sessions were announced in the Federal Register, were open to the public, and provided an opportunity for public input.⁶ On September 23, 1996, MMS published a notice of proposed rulemaking (61 FR 49894) to amend the valuation regulations for gas production from Indian leases.

The new rule provides a methodology to calculate the value of production for standard tribal and allotted Indian leases that provide for the value to be based on factors including the highest price paid or offered for a major portion of gas (major portion) at the time royalty payments are due. Many areas of production base value on published index⁷ prices for gas production from leases on reservations. The new rule also provides an alternative methodology for dual accounting. Thus, the lessee can elect to simplify the calculations for the requirement to pay royalties on the greater of the combined value of the residue gas and gas plant products resulting from processing the gas, or the value of the gas prior to processing.⁸

The rule eliminates in certain situations the need to calculate specific transportation allowances. Also, the rule eliminates processing allowance calculations for lessees choosing the alternative methodology for dual accounting. In addition, the rule eliminates the requirement to

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file transportation or processing allowance forms in anticipation of claiming an allowance. In cases where lessees claim non-arm's-length allowances, the lessee stills submits the data to verify the allowance claimed.

III. How Does the Lessee Value Gas Production In an Index Zone?

What Leases the Index-Based Valuation Method Applies

Under the regulations at 30 CFR § 206.172 (64 FR 43517), lessees must value production using the index-based valuation method if their lease is in an index zone and meets one of the following two requirements:

1. Has a major portion provision.

2. Does not have a major portion provision, but provides for the Secretary to determine the value of production.

The index-based method does not apply to carbon dioxide, nitrogen, or other non-hydrocarbon components of the gas stream. However, if the lessee does recover these and sells them separately from the gas stream, then the lessee must determine the value under 30 CFR § 206.174 (64 FR 43520), the non-index based valuation method.⁹

Valuing Residue Gas and Gas Before Processing

Under the new regulations, lessees use the index-based method to value gas production for the following four types of gas:¹⁰

1. Gas production before processing.

2. Gas production that the lessee certifies on Form MMS-4410, Certification for Not Performing Accounting for Comparison, gas is not processed before it flows into a pipeline with an index but which may be processed later.

3. Residue gas after processing.

4. Gas that is never processed.

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Lessees use the index-based method for gas that is not sold under an arm's-length dedicated¹¹ contract unless the gas was subject to a previous contract which was part of a gas contract settlement. If the previous contract was subject to a gas contract settlement and if the royalty-bearing contract settlement proceeds per MMBtu added to 80 percent of the safety net prices exceeds the index-based value (including any adjustments for dual accounting), then the value of the gas is the higher of the index-based value (including any adjustments for dual accounting) or the value under the non-index based method.

The value of gas produced from an index zone that is sold under an arm's-length dedicated contract is the higher of the index-based value or the value of that production determined under the non-index based method.

Valuing Gas That is Processed Before It Flows Into a Pipeline With an Index

Under the new rule, lessees must value gas that is processed before it flows into a pipeline with an index based on the higher of the following two values:¹²

1. The value of the gas before processing.

2. The value of gas after processing, which is either the alternative dual accounting value or the sum of the following three values:

a) The value of the residue gas.

b) The value of the gas plant products less any applicable processing or transportation allowances.

c) The value of any drip condensate associated with the processed gas.

Determining the Index-Based Value for Gas Production

The new rule requires that lessees use the following procedure to determine the index-based value of gas produced from leases in an index zone:

• Calculate the average of the highest reported prices for all index-pricing points in the index zone for each MMS-approved publication. MMS approved publications are Inside F.E.R.C.'s Gas Market Report and the Natural Gas Intelligence Weekly Gas

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