MMS proposes changes to federal oil royalty rules

Sept. 8, 2003
MMS proposes changes to federal oil royalty rules The US Minerals Management Service Aug. 22 proposed industry-supported changes to its 2000 oil valuation rule that the agency said it considers to be technical rather than philosophical in nature.

The US Minerals Management Service Aug. 22 proposed industry-supported changes to its 2000 oil valuation rule that the agency said it considers to be technical rather than philosophical in nature.

"The existing rule was published in 2000, and though it does provide the federal government and lessees with a fair return on federal resources, our 3 years of experience with the rule prompted us to review some technical issues such as transportation costs and price indices used in valuing oil from federal leases," said MMS Director Johnnie Burton.

The proposal is on a regulatory fast track. Comments are due Sept. 19, and MMS said it hopes to issue a final rule less than 2 weeks later, in October.

The Independent Petroleum Association of America and the American Petroleum Institute sued MMS over duty- to-market issues related to the 2000 rule. IPAA last month said its review of the proposal just began, but generally speaking, MMS "seems to have taken a careful adjustment" of the existing rule, with many of the changes reflecting suggestions discussed by MMS and the public. Industry's lawsuit is still active despite other largely unfavorable appeals court rulings on the issue.

During four public workshops in March, MMS gathered information and comments that form the basis of the proposed changes to the controversial 2000 regulations. The current rules changed the way MMS calculated royalties for crude oil sold between related parties. After 4 years of debate and four drafts, the agency retooled its oil valuations from an outdated company posted price method to a system that generally relies on published spot prices at benchmarked market centers. (In the Rocky Mountain region, spot prices are the basis for a third benchmark).

MMS said in an Aug. 20 Federal Register notice that its proposed amendments do not alter the basic structure or underlying principles of the June 2000 rule.

"In proposing these amendments the Department of the Interior reaffirms that the value for royalty purposes of crude oil produced from federal leases is value at or near the lease," the agency said. "But in determining value at the lease of production not sold under arm's length contract at the lease, MMS is not restricted to a comparison to arm's length sales of other production occurring in the field or area. MMS may begin with a 'downstream' price or value and determine value at the lease by deducting the costs of transporting oil to downstream sales points or markets or by making appropriate adjustments for location and quality."

Those adjustments became a continual source of friction between the agency and producers. Many industry players urged MMS to sidestep that lingering dispute by expanding royalty-in-kind programs that have the government take its royalty share in product instead of cash. MMS currently has several RIK pilot programs and is in a joint program with the Department of Energy in which federal royalty oil is deposited in the Strategic Petroleum Reserve. A pending energy bill in Congress strongly encourages MMS to expand RIK, although some state royalty collectors and a recent General Accounting Office report found there still may be too many administrative flaws to rely on it exclusively.

Proposed changes

MMS wants to change its valuation basis for transactions not at arm's length from spot to New York Mercantile Exchange futures prices adjusted for locality and quality differentials. The agency said that use of the NYMEX price as the basis for royalty value may represent "a more reliable and better assessment of current oil values than spot prices." (Rocky Mountain crude would remain under its existing benchmark system, the agency said.)

MMS maintains that an advantage of using NYMEX might be that the volume of transactions and the number of participants are so large that "at least theoretically no one entity could manipulate the resultant price." MMS said this is an issue partly because of the recent publicity and questions about the information provided to spot price reporting services in the natural gas market and the effect such potentially inaccurate information might have on spot prices in general.

In comments to MMS earlier this year price publishers such as McGraw-Hill Cos.' energy information division, Platts, said it provides consistent and reliable price levels and transparency to markets in which billions of dollars of contracts are based.

MMS also said it wants to change the rate of return on undepreciated capital investments to 1.5 times the Standard & Poor's BBB rate.

Other changes include clarifying the treatment of transactions under a joint operating agreement and providing greater specificity regarding the transportation costs companies are allowed to deduct.

Other stakeholder views

Some state interests that share federal royalty proceeds argued MMS simply acquiesced to industry demands because of unfavorable court rulings.

"This is a sham rulemaking. MMS made up its mind to modify the rules within weeks of the Supreme Court's rejection of industry's silly duty-to- market claims. Apparently whatever industry loses in court, MMS will rectify by changing the rules," said Lee Helfrich, partner at Washington, DC-based law firm Lobel, Novins & Lamont, and counsel to the California State Controller's office.

"MMS says that its 'experience' under the 2000 rules is motivating its current proposal. But the fact is that MMS has no experience under the 2000 rules. Industry challengedU[former President Bill Clinton's] rules in court—and apparently the new Interior under the [President George W.] Bush administration is afraid it might win the case," Helfrich said.