Industry eyes next step in MMS gas royalty dispute

Maureen Lorenzetti
OGJ Online

WASHINGTON, DC, Feb. 22 --Oil companies that drill on federal lands are mulling an appeal to the US Supreme Court following a recent decision by the US Court of Appeals for the DC Circuit that largely affirmed the Minerals Management Service's "duty to market" gas royalty rules.

Industry has several legal options it still can consider: it can file a petition for rehearing before the full appeals court by March 25; it can also petition the Supreme Court before May 9. Industry could also seek a rehearing before another appeals court.

Producers say downstream marketing adds to the value of the gas at the lease, and therefore the royalty owner should share the costs with the government.

It may be several weeks before industry officials decide to pursue more litigation. And on the regulatory front, things are equally unclear, government officials and industry lobbyists say. MMS is unlikely to further tinker with its existing gas royalty rules in the near future for two key reasons, sources say. First, the agency wants to wait until legal challenges are settled; second, a new director, R.M. "Johnnie" Burton, former Revenue director of the state of Wyoming, does not take office until next month and it will take some time for any new policy directions to be set in motion.

According to the Feb 8 decision, the American Petroleum Institute and Independent Petroleum Association of America argued MMS was wrong for refusing to permit deductions for costs incurred in marketing gas to markets downstream of the wellhead. Industry's legal arguments focused on fees incurred in aggregating and marketing gas with respect to downstream sales; "intra-hub transfer fees" charged by pipelines; and any unused pipeline demand charge.

The appeals court reversed an earlier district court's decision, and ruled that Interior's method of calculating downstream marketing costs was fair. On the unused demand charge issue, the court ruled in favor industry and affirmed the district court ruling.

"We find nothing unreasonable in Interior's refusal to allow deductions for so-called 'downstream' marketing costs," the court opinion said.
And on the unused pipeline issue, the court agreed with producers' assertion that the cost of reserving space on a pipeline i.e. the demand charge" should be considered by MMS.

The district court ordered MMS and industry to share the cost of the reservation fee, and the appeals court said the government offered no reason why industry should be liable for the entire amount.

"While some reason may lurk behind the government's position, it has offered none, and we have no basis for sustaining its conclusion," the court wrote.

Gas rule
MMS in 1997 sought to update the way it calculates gas royalty payments in light of sweeping changes made by the Federal Energy Regulatory Commission in the mid-to late 1980s to open the wholesale gas market to competition. The agency revised the way it calculated transportation allowances which industry opposed and ultimately led to the appeals court latest action. MMS also considered but never implemented
a plan that would have allowed natural gas producers to use independent spot-market price indexes as a way to calculate royalty payments for most leases.

Larger producers wanted the option of using a spot-market index but smaller independents said indexes were too complicated. Three years later, MMS imposed a similar rule for oil. But in that case of oil both majors and independents opposed the rule saying in the case of crude oil market indexes should not be considered because they do not reflect the true value of the oil at the wellhead. The oil valuation rule is in effect but may also face its own legal challenges down the road, lobbyists say.

Even though the controversial gas rule was never finalized, American Petroleum Institute and Independent Petroleum Association of America sued MMS in 1998 because they were unhappy with how much credit the Interior Department agency gives lease holders for transportation costs.

Close to two-thirds of the royalty money collected from MMS typically is from gas. In 1998 for example MMS collected $2.3 billion in gas royalties, compared to collecting $1.1 billion in oil royalties, from companies drilling on federal and Indian lands.

In other related legal action, the Justice Department over the past 2 years intervened in five separate False Claims Act lawsuits filed by industry whistleblowers alleging that major oil and gas companies undervalued gas in order to avoid paying royalties owed to the federal government and Indians. Three cases are pending in the 10th Circuit U.S. District Court for the District of Wyoming.