After 4 years and four revisions, the US Minerals Management Service has issued a final rule revising how producers calculate the cash royalties they owe on production from federal lands.
The rule affects about 230,000 b/d of federal royalty oil, less about 50,000 b/d being sold through royalty in-kind and small refiner programs or being transferred to the Strategic Petroleum Reserve. MMS said, overall, federal leases produced about 1.7 million b/d last year.
MMS is allowing producers a 3-month, interest-free grace period to give them time to change their accounting systems to comply with the regulation.
Separately, MMS plans to issue a final rule in mid-May on the valuation of royalties from production on Indian lands.
US oil industry groups are expected to ask a federal judge to block implementation of the federal-lands royalty rule or sue to overturn it, or both.
The Independent Petroleum Association of America (IPAA) said its board of governors has authorized it to pursue litigation options, especially over a provision stating the lessee has a duty to market royalty oil.
The American Petroleum Institute said it must study the final rule before determining if it would sue.
MMS said the rule, which eliminates most uses of posted prices to determine royalty values, will increase federal royalty revenues by $67.3 million/year. It said the net effect on the oil industry would be $63.5 million, because producers would save about $3.8 million/year from not having to file administrative appeals.
MMS said producers are unlikely to pass their additional royalty costs on to consumers, but if they did, they would amount to less than 0.1¢/bbl of refined product.
The agency said the 10 major integrated oil companies will pay 88% of the additional revenues, large independent producers with refining capacity will pay 8%, and small producers will pay the rest.
MMS Director Walt Rosenbusch said, "The key feature of this rule is the application of spot market pricing for the major integrated companies and others that refine their [own] oil.
"In other words, this provision does away with reliance on posted prices for non-arm's-length contracts. We continue to believe that spot market pricing is by far the best indicator of crude oil's true value in today's market."
MMS said the rule would allow it to accept royalty oil values determined by prices set in arm's-length contracts with buyers.
"Thus, small, independent producers that sell under arm's-length contracts will not be affected."
MMS agreed to language affirming that its auditors will not second-guess producers' marketing decisions in arm's-length sales.
For sales that are not arm's-length, MMS would determine values using market-based spot pricing-with adjustments for transportation and quality differentials. Different valuation methods would be used for different areas of the country, particularly the Rocky Mountains.
In California and Alaska, the value would be tied to Alaskan North Slope crude, with adjustments.
In the Rocky Mountains, MMS will allow values to be set by tendering because "...spot markets are less robust where more oil is sold at arm's length. We also place substantial restrictions on tendering programs there to ensure that [it] could only be used in situations where the lessee committed significant volumes to the programs and obtained bids from a number of potential buyers."
Also, MMS will allow Rocky Mountain royalty values to be set by arm's-length or spot pricing, where applicable.
In the rest of the US, prices would be determined by the spot price at market centers, adjusted for location and quality differentials.
The rule allows producers the actual costs of transportation, allows for depreciation on pipelines, stipulates clearer criteria for determining company affiliation, and binds MMS to its value determinations.
Despite the urgings of producers, the rule does not allow marketing costs as a deduction from royalties.
MMS said it is "a well-established principle of oil and gas law that lessees have the duty to market production for the mutual benefit of the lessee and the lessor, with no deduction for costs of marketing.
"We understand that some oil companies disagree with our view, and we are involved in litigation on the issue with respect to gas. Ultimately, it will be up to the courts to decide who is right."
Rosenbusch said MMS made some significant changes in the proposed rule since January 1997. It moved away from New York Mercantile Exchange prices to spot prices, allowed arm's-length contracts to set values, and provided options for exchanges and affiliate-company resales.
Also, it removed the presumption that companies control affiliates if they hold even a minority interest in them. It set lease-based benchmarks for the Rocky Mountains.
Further, MMS provided assurance it would not second-guess deals, completely dropped reporting form No. 4415, allowed itself to be bound by its own value-determination rulings, and eased the calculation of transportation costs.
IPAA said MMS made no significant changes from the supplementary proposed rule that it issued last December.
It said MMS has allowed producers additional depreciation on their transportation costs, but they are not close enough to the actual cost of transportation. It said MMS made no improvements for independents that market their own production, refused to alter its duty to market position, and made no improvements in the area of comparable sales.
API said, "We are disappointed. Throughout the rulemaking, we sought a system that provided our companies with more certainty, a system that would move us away from all this needless litigation.
"This new plan does not move us in that direction at all. It will lead to more lawsuits in the future because the system is getting more complex, not less complex.
"What we have in the final rule is a methodology that in many cases ignores sound measures of value at the lease. It uses instead downstream indices and then categorically excludes allowances for post-production marketing costs.
"The result is an inflated value of production and unlawfully inflated royalty obligations."
The key feature of this rule is the application of spot market pricing for the major integrated companies and others that refine their own oil...We continue to believe that spot market pricing is by far the best indicator of crude oil's true value in today's market.