MMS lists options for royalty rule changes

The U.S. Minerals Management Service has released alternatives for proceeding with its controversial oil valuation rule (OGJ, Sept. 15, 1997, p. 25).

The rule would require the value of most production to be set on the average of New York Mercantile Exchange futures prices, adjusted for crude quality and location. It was amended in July to allow independent producers to use the value of crude sold in arm's-length transactions.

MMS said it will discuss the options with state and industry representatives during workshops Sept. 30-Oct. 1 at its Lakewood, Colo., office and Oct. 7-8 at its Houston office. It will hear public comments at an Oct. 14 hearing in Houston.

It will accept written public comments on the alternatives until Oct. 22 and then issue a revised notice of proposed rulemaking.

Reactions

The agency issued the proposed rule Jan. 24, held public meetings in the spring, and then issued a supplementary proposed rule. It has received 76 written and 32 verbal comments.

MMS said states generally support the proposed rule, although each had specific suggestions for improvement. Some states support allowing more payors to pay royalties based on gross proceeds received under arm's-length contracts.

It said, "The oil and gas industry, both major and independent producers, oppose the proposed rule as well as the supplementary proposed rule. Many industry commenters argued that MMS does not have the legal authority to value production away from the lease and that the Nymex valuation method is flawed.

"They believe that value is added by transporting and marketing the oil away from the lease and that this added value exceeds the cost of transportation alone. Many industry commenters stated that futures prices don't provide a dependable measure of current value and that an active lease market does exist for valuing crude oil.

"Others argue that Rocky Mountain region prices don't track with Nymex prices due to the isolated nature of that market."

MMS said nearly all industry commenters suggested the agency take its royalty in-kind (RIK) to assure that it receives fair market value for its production.

Oil firms said the proposed method for using differentials to calculate royalty values at aggregation points would be an administrative burden, require data that are not available to many lessees, ignore seasonal effects on prices, and exclude many costs that should be allowed as a deduction.

Alternatives

MMS asked for comment on three changes to its rule regarding benchmark prices, differentials, and index pricing. It said it would not consider RIK as an alternative at this time.

On benchmarks, MMS said several industry commenters suggested lessees value production not sold under an arm's-length basis according to prices they receive for outright sales of crude in a particular market area or region. Such a program is called a bid-out, or tendering, program.

MMS asked if a minimum volume of production should be required to be tendered in a given area before such a price would be acceptable for valuing the remainder of a lessee's production not sold at arm's-length.

It said other benchmarks that could be used are: the lessee's or its affiliate's arm's-length purchases from producers at the lease in the field or area, outright arm's-length sales by third parties, prices published by MMS based on its RIK sales, or via netback employing price information from the nearest market center or aggregation point.

MMS said several industry and state commenters said the proposed form for calculating differentials would be too burdensome on lessees.

It asked for comments on alternatives for determining the appropriate location and quality differentials to be deducted from the Nymex method, particularly the differential in cents per barrel by zone or area, in cents per mile by zone or area, or based on a percentage of the Nymex value.

It also requested comments on alternatives for determining quality differentials from the lease to the market center.

On indexing, one state suggested MMS use published spot prices instead of Nymex. MMS asked for comments on whether it could use indices and then allow a deduction for the cost of transportation to the market center where the spot price is published.

RIK opposed

Opponents to RIK testified at a recent House resources subcommittee hearing. Members of the panel are working on draft RIK legislation.

Danielle Brian, executive director of the Project on Government Oversight, said, "RIK would lock the federal government into the same powerless condition where we must accept whatever price is offered to us by the companies that control or own local pipelines.

"So we end up back where we started with one of the longest-running corporate welfare schemes of this century: posted prices."

Ed Rothschild, Citizen Action's energy policy director, said, "We are struck by the irony of the industry now wanting to get the government into the oil business after arguing vociferously about the need to get the government out of the business."

The Congressional Research Service raised the same issue.

In a report to the committee, it said RIK "would require an effective system for marketing the federal government's oil and gas shares and could lead to significant government involvement in oil and gas markets."