WYOMING'S POWDER RIVER BASIN: A CASE STUDY IN FEDERAL ROYALTY VALUATION

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management Book 1
(Feb 2004)
CHAPTER 18A
WYOMING'S POWDER RIVER BASIN: A CASE STUDY IN FEDERAL ROYALTY VALUATION
Thomas F. Reese, Esq. ¹
Drake D. Hill, Esq. ¹
Brown, Drew & Massey, LLP
Casper, Wyoming

I. Introduction

The past several years have seen a proliferation of litigation relating to royalty valuation and the deductibility against royalty interests of certain post-production costs. This litigation has been driven by attorneys for private royalty owners attempting to find ways of shifting the costs onto the producers that, historically, royalty owners have shared under their leases.

Private royalty owners have focused their arguments on lines exempted from Federal Energy Regulatory jurisdiction ("FERC") as non-jurisdictional "gathering" lines. The focus of royalty litigation has been whether these lines and other costs incurred away from the lease line are production related expenses that private royalty owners are not obligated to share in, or whether they are post-production costs that are chargeable to royalty owners.

Like private royalty owners, the Minerals Management Service ("MMS") has recently demonstrated its desire not to share in certain downstream transportation costs. The MMS has not taken the position of private royalty owners that the "gathering" lines that find exemption from FERC jurisdiction are production related gathering costs in which the MMS should not be required to share. The MMS, rather, argues that coalbed natural gas is marketable at or near the well for purposes of the transportation allowance, but is not marketable for some down stream transportation functions like some compression, dehydration, and CO%l2%l removal. Under the MMS's regulations, the case law, and as a factual matter, the MMS's arguments for allowing certain downstream costs while disallowing others is not persuasive.

II. Production vs. Post-Production Costs

Within the terms of federal oil and gas leases is the requirement that the "royalty on production removed or sold from the leased lands (is to be) computed in accordance with the Oil and Gas Operation Regulations. . ." The operating regulations governing the valuation of gas for the purpose of computing the federal royalties are now found in 30 CFR §§ 206.150 et seq. (2003). Section 206.151 contains definitions of "gathering" and of the "transportation allowance:"

"Gathering" means the movement of lease production to a central accumulation and/or treatment point...

"Transportation allowance" means an allowance for the reasonable, actual costs incurred by the lessee for moving unprocessed gas, residue gas, or gas plant products to a point of sale or point of delivery off the lease, unit area, communitized area, or from a processing plant, excluding gathering, or an approved or MMS-initially accepted deduction for costs of such transportation, determined pursuant to this subpart.

Also see § 206.156(a):

Where the value of gas has been determined...at a point (e.g., sales point or point of value determination off the lease), MMS shall allow a deduction for the reasonable actual costs incurred by the lessee to transport unprocessed gas, residue gas, and gas plant products from a lease or a point off the lease including, if appropriate, transportation from the lease to a gas processing plant off the lease and from the plant to a point away from the plant.

These operating regulations have been in force since 1988. The federal system does not allow a deduction for the costs of gathering, defined as gathering close to the lease line, but does allow a deduction of the costs of transportation of the gas from the lease. The federal regulations demonstrate that the MMS recognizes the clear distinction between what is meant by "gathering" for royalty valuation purposes, and how that term is applied by agencies exercising different jurisdiction than the MMS, such as how the term "gathering" is used by FERC in regulating the interstate transportation of natural gas, or as defined in the Pipeline Safety Act.

In comparison, in Wyoming, and in other jurisdictions where natural gas is produced, costs of transportation of gas from the place of production to a processing plant or to a distant point of sale have likewise been shared by royalty owners. See State of Wyoming v. Davis Oil Co., 728 P.2d 1107, 1109 (Wyo. 1986) and Kretni Development Co. v. Consolidated Oil Corporation, 74 F.2d 497 (10%gth%g Cir. 1934), a case arising in Wyoming. For decisions on this point from other jurisdictions see, e.g.,Heritage Resources, Inc. v. NationsBank, 939 S.W.2d 118, 122 (Tex. 1996); Johnson v. Jernigan, 475 P.2d 396, 399 (Okla. 1970); Sternberger v. Marathon Oil Co., 894 P.2d 788, 799-800, (Kan. 1995).

Under the Wyoming Royalty Payment Act ("the Act"), %sWyo. Stat. (Ann%s.) §§ 30-5-301 through 30-5-305 (LexisNexis 2003), the lease controls the payment of royalties. %sWyo. Stat. (Ann%s.) § 30-5-305(a) . In the rare instances in which no express lease terms define royalty payment, royalty interests are defined to mean a "share of production, free of the costs of production . . ." %sWyo. Stat. (Ann%sN.) § 30-5-304(a)(vii) . Under subparagraph (vi) of subsection 304(a), "Costs of production" means,

all costs incurred for exploration, development, primary or enhanced recovery and abandonment operations including, but not limited to lease acquisition, drilling and completion, pumping or lifting, recycling, gathering, compressing, pressurizing, heater treating, dehydrating, separating, storing or transporting the oil to the storage tanks or the gas into the market pipeline. "Costs of production" does not include the reasonable and actual direct costs associated with transporting the oil from the storage tanks to market or the gas from the point of entry into the market pipeline or the processing of gas in a processing plant;

%sWyo. Stat. (Ann%s.) § 30-5-305(a)(vi) (emphasis supplied).

The use of the term "gathering" in the context of the definition...