The Minerals Management Service has begun auditing recent U.S. natural gas purchase contract settlements.

Under scrutiny are contracts in which producer and buyer have agreed to price changes, take or pay settlements, buydowns, or buyouts.

It estimated the more than 1,700 audits, some of which will take until 1996, will reap $200-400 million in revenues for the federal government.

MMS has been developing a policy on contract settlements, which it recently released. Goal of the policy is to ensure that MMS collects royalties on payments received under contract settlement agreements to the extent the payments flow from production on federal and Indian leases.

In a letter to all federal lessees, MMS said, "Lease terms require that royalties be paid on quantities produced, removed, and sold. Royalty value is based on the gross proceeds accruing to the lessee for the disposition of products produced."

James Shaw, associate MMS director for royalty management, said many of the settlements involve more than one issue. For example, they might involve a take or pay settlement and a buydown.

COURT DECISION

He said industry has been very cooperative so far, and 99% of the companies involved have agreed to give MMS more time to develop the policy.

The MMS policy is based on a 1988 lawsuit, Diamond Shamrock Exploration Co. vs. Hodel, in which the Fifth Circuit Court of Appeals ruled that royalties are not due on take or pay payments until the production to which the take or pay payment is attributable occurs.

Consistent with that, MMS holds that a payment or a portion of a payment is royalty bearing if the mineral to which the payment is attributable is produced and sold either to the original purchaser or a substitute purchaser as part of the "gross proceeds" received for disposition of that production under applicable rules.

In past price disputes, MMS said the portion of the settlement payment made to resolve disputes regarding the proper price owed for production before the settlement agreement is royalty bearing when the lessee receives the payment.

It said take or pay settlement payments that are expressly subject to future recoupment through makeup deliveries are royalty bearing when and to the extent recouped. And payments not expressly subject to future recoupment through makeup deliveries may be royalty bearing in some cases.

In contract buydowns, the portion of the settlement payment made to reduce the price to be paid for future production to be taken by the original purchaser under an amended or successor contract is royalty bearing as future production occurs.

In contract buyouts, payments made to end a purchaser's obligation to take volumes in the future are royalty bearing to the extent that production of the bought out volumes continues from the lease under any successor contract with any purchaser during the term of the original contract.

Copyright 1993 Oil & Gas Journal. All Rights Reserved.

MMS AUDITING GAS PURCHASE CONTRACT SETTLEMENTS

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