WATCHING GOVERNMENT: Royalty ruckus

Patrick Crow
Washington, D.C.
[email protected]

The Minerals Management Service's pending royalty valuation rule is the hottest issue confronting oil groups in Washington.

MMS, responding to alleged royalty underpayments (OGJ, Oct. 28, 1996, p. 19), wanted to reduce the use of posted prices for calculating royalties owed on oil from federal leases.

So it proposed basing most royalties on the monthly average of New York Mercantile Exchange prices, less adjustments for crude quality and location (OGJ, Jan. 27, 1997, p. 36).

Some large producers use Nymex for hedging, and they say it only reflects traders' expectations for the oil market and is not necessarily an accurate reflection of the value of crude in the field.

Due to small producers' complaints, MMS said it plans to issue a revised proposal within 2 weeks to allow them to base royalties on gross sale proceeds.

A MMS official said, "We are not backing away from Nymex for non-arm's length sales." And she asked if Nymex isn't relevant, why do producers often use it to set prices in sales and exchange contracts?

Industry's remarks

American Petroleum Institute said, "The proposal would scrap the existing regulations in favor of an untried and hopelessly flawed indexing scheme.

"It unnecessarily contracts the use of gross proceeds, whether realized through arm's length contracts or a wide variety of other transactions, all of which play an important part in today's complex crude oil market."

API said oil firms would have to collect stacks of data and extensively revamp their royalty payment systems without a tangible increase in benefits.

"The proposed index-driven scheme simply starts at the wrong end of the market. And the simplistic adjustment mechanisms proposed cannot begin to bridge the gap between index prices and prices realized at the lease market."

The Domestic Petroleum Council, representing 17 medium-sized producers, said, "Most of the time, the proposed methodology will result in an overvaluation of the government's royalty share."

DPC and others also argue MMS has not shown the need to change the current rules. That could be the basis for an industry lawsuit later.

Royalty in kind

Almost all producers have urged MMS to simply take its share of oil (royalty in kind), or take and sell some of its RIK oil to establish benchmark prices.

MMS is wary about that because its Gulf of Mexico RIK gas pilot project lost money. Meanwhile, it is examining Alberta's oil RIK program.

An Independent Petroleum Association of America official said, "MMS, with their market power, could receive more revenue, and they would have great administrative savings" through an oil RIK.

The agency has about 3% of domestic output, and taking the oil would allow it to dismiss hundreds of auditors and administrators.

Producers also cite a fundamental flaw in the rule: The law requires MMS to collect a fair price for federal royalty oil. But in the rule, MMS has unrealistically interpreted that to mean the best possible price.

Oilmen say MMS should realize that in a free market, producers just don't get the best price every time.