TRANSPORTATION ALLOWANCES AND THE MARKETABLE CONDITION DOCTRINE
| Jurisdiction | United States |
(Feb 2004)
TRANSPORTATION ALLOWANCES AND THE MARKETABLE CONDITION DOCTRINE
Mineral Audit Division - Department of Audi
State of Wyoming
Cheyenne, Wyoming
Introduction
Methane associated with coal is nothing new, but the proliferation of new coalbed methane wells being developed and produced is a relatively new phenomenon. Wyoming as well as several other Western states are experiencing large-scale increases in the production of coalbed methane (CBM). The purpose of this paper is to briefly discuss transportation allowances and the marketable condition doctrine related to coalbed methane production.
This paper is in response to an invitation to present the Wyoming Mineral Audit Division's position on these issues. I have focused on development in the Power River Basin, because of my familiarity with issues in this area of Wyoming, and also due to the recent Devon valuation determination issued by the Minerals Management Service (MMS). However, the basic concepts discussed herein should be applicable to coalbed methane production in general.
"Generally speaking, coalbed methane differs from other natural gas produced in Wyoming. It is typically produced at lower pressure. It has lower flow rates per well. Coalbed methane is not complex natural gas, that is, coalbed methane does not contain heavy hydrocarbons and has few impurities. Because coalbed methane does not have heavier hydrocarbons, there is no byproduct stream of natural gas liquids that can be used to generate revenue, nor any need to separate out oil or other liquid hydrocarbons." 1
Overview of Power River Basin Coalbed Methane
The overall layout throughout the Powder River Basin is similar. Coalbed methane exists within the coal seams. In the Powder River Basin the average depth of the wells and the production pressures are similar. There are many fields within the Powder River Basin. Therefore the field characteristics and layout described in the Devon Energy determination were selected to provide an overview of an example field to keep the discussion consistent.
Field characteristics and layout
The following overview of an example field layout is offered to enhance understanding of the basic operational scheme as is relevant to the issues set out below and is not intended to be a detailed description. 2 In 1998 Devon and KN Energy, Inc. (KN Energy) formed Thunder Creek as a partnership. Thunder Creek is owned 75% by Devon and 25% by KN Energy. Thunder Creek operates a 24-inch high-pressure pipeline. This pipeline starts at the Landeck Station (sometimes called the "Landeck header") and extends approximately 126 miles south to the Buckshot Gas Plant between Douglas and Glenrock, Wyoming. Thunder Creek also operates several smaller-diameter systems that connect to the 24-inch pipeline. The smaller-diameter Thunder Creek lines move Devon's gas produced from Kitty and Spotted Horse Fields to the 126-mile 24-inch high-pressure pipeline. A smaller-diameter line operated by Bitter Creek Pipelines, LLC (owned by Williston Basin Interstate ("WBI")), moves the gas produced from the Rough Draw Field to the 126 mile Thunder Creek pipeline. "Devon operates the Kitty and Spotted Horse Fields. Redstone Resources, Inc., a firm not affiliated with Devon, operates the Rough Draw Field." 3
The three above named fields operational scheme is very similar. There are a large number of individual wells that produce coalbed methane gas. These individual wells are gathered to one of the many central delivery points (CDPs) in each of the fields. There are several CDPs in each of the fields, and each CDP gathers between 2 and 30 wells. The CDP is the Bureau of Land Management (BLM) approved royalty measurement point.
For example in the Kitty and Spotted Horse Fields, there is a two-phase separator at each CDP to remove water. The gas leaves the CDP and enters a small-diameter low-pressure Thunder Creek pipeline. "A short distance from the CDP building, the gas passes through a custody transfer meter (maintained by Thunder Creek in the Kitty and Spotted Horse Fields and by Williston Basin Interstate Pipeline Co. in the Rough Draw Field)." 4 From the custody transfer meter, the gas travels to a screw compressor, which can be located a few feet to several miles away. At the inlet to the screw compressor the gas is between 2 and 10 psig (pounds per square inch gauge), and contains a carbon dioxide (CO%l2%l) content of between 1 and 8 percent. The outlet pressure for the screw compressors ranges from about 80 to 100 psig.
The next step in the production process is for the gas to continue down the small-diameter low-pressure Thunder Creek line to a reciprocating compressor referred to as a field booster for a distance that ranges from .1 mile to approximately 5.7 miles. The gas also passes through a dehydrator immediately after the reciprocating compressor. There are two reciprocating compressors in the Kitty field and two reciprocating compressors in the Spotted Horse Field. The gas enters the reciprocating compressors at a pressure range of about 80 to 100 psig and is compressed to roughly:
• 550 psi for gas from the Kitty Field,
• 800 psi for gas from the Spotted Horse Field,
• and 600 psi for gas from the Rough Draw Field.
There is a MTG Compressor Station approximately 28 miles south of the Landeck Station along the 126-mile, 24-inch high-pressure Thunder Creek pipeline. The MTG Station contains a large compressor called the "MTG Booster." The MTG Station compresses the gas from an inlet pressure of between 450-500 psi to 1,200 psi. The gas then travels down the remaining 98 miles of 24-inch high-pressure Thunder Creek pipeline to the Buckshot Plant.
At the Buckshot Plant the gas is treated. 5 The CO%l2%l is removed, the gas is further dehydrated and compressed to market pipeline specifications and delivered to either the CIG Powder River Lateral pipeline or the Wyoming Interstate Medicine Bow pipeline.
The process of gas gathering, dehydration, compression and transportation raises questions about who should bear the cost of these functions. Should the 7/8 share of the gas relinquished by the royalty owners to produce the gas bear the cost of these functions or should the cost of these functions be carved out of the remaining 1/8 share paid to the royalty owners.
Applicable Law
The Standards for valuing unprocessed federal gas are contained in 30 C.F.R. § 206.152 .
30 C.F.R. § 206.152(h) states: "Notwithstanding any other provision of this section, under no circumstances shall the value of production for royalty purposes be less than the gross proceeds accruing to the lessee for lease production, less applicable allowances." Gross proceeds for royalty purposes are defined under 30 C.F.R. 206.151 Definitions. Gross proceeds include more than "the total monies and other consideration accruing to an oil and gas lessee for the disposition of the gas, residue gas, and gas plant products produced." Gross proceeds also "includes, but is not, limited to, payments to the lessee for certain services such as dehydration, measurement, and/or gathering to the extent that the lessee is obligated to perform them at no cost to the Federal Government." 30 C.F.R. 206.151 .
30 C.F.R. § 206.152(i) further clarifies that: "The lessee must place gas in marketable condition and market the gas for the mutual benefit of the lessee and the lessor at no cost to the Federal Government. Where the value established under this section is determined by the lessee's gross proceeds, that value will be increased to the extent that the gross proceeds have been reduced because the purchaser, or any other person, is providing certain services the cost of which ordinarily is the responsibility of the lessee to place the gas in marketable condition or to market the gas." (Emphasis added.) Marketable condition for royalty purposes is defined under 30 C.F.R. 206.151 Definitions: "Marketable condition means lease products which are sufficiently free from impurities and otherwise in a condition that they will be accepted by a sales contract typical for the field or area."
However, the case law often looks to the standards that the gas must meet to enter an interstate transportation pipeline or market pipeline.
Marketable Condition Doctrine
"The regulations have historically called for a calculation or royalty on the basis of 'gross proceeds."' 6 The Department of Interior (DOI) "has applied the Marketable Condition Rule consistently to all 'gross proceeds' . . . since the Rule was promulgated in 1954." 7 Thus for about half a century or longer, DOI has taken and defended the position that gas needs to be placed in marketable condition at no cost to the federal government. 8 The United States Court of Appeals, Tenth Circuit has reiterated as recently as March 25, 1999 that the long standing doctrine known as the marketable condition rule is still in effect. The Court in Amerada Hess while addressing an offshore issue of transportation verses the marketable condition and gross proceeds rules, cited in two footnotes the CFR sections discussed above, 30 C.F.R. §§ 206.152(i) and 206.152(h) . 9
Marketable Condition Components
The Department of Interior's regulations require that royalties are due on the "gross proceeds" which must include "payments for the costs of treatment including measuring, gathering, compressing, sweetening and dehydrating 'where such services are necessary to place gas in marketable condition,'. . ." 10 Dehydration, compression and CO%l2%l removal are readily identifiable components of the marketable condition doctrine.
Dehydration
"As produced, natural gases are generally saturated with water as a result of contact with water or brine in the formation. Dehydration is required to prevent water condensation and the formation of gas hydrates in...
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