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MMS Issues Final Royalty Rule on Natural Gas Valuation

March 14, 2005
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The Minerals Management Service (MMS) issued a final rule Thursday amending existing regulations for natural gas valuation for royalty purposes, increasing the rate of return used in valuing non-arm's-length transportation from 1.0 to 1.3 times the Standard and Poor's BBB Industrial Bond rate, and clarifying other parts of the transportation deduction from the sale price of gas. The final rule substantially followed the lines of the proposed rule for collection of royalties from federal lands issued last year (see NGI, July 26, 2004).

The new rule provides allowances or subtractions from the valuation for the reasonable, actual costs -- excluding gathering costs and brokers' fees -- of moving gas to a point of sale or delivery. It clarifies that a FERC- or state-approved pipeline tariff rate or discounted tariff rate, may be substituted for actual costs, and that unused demand charges that are paid also may be deducted, pursuant to a federal court decision. It allows fees paid (either in volume or in value) for actual line losses to be counted as a cost of transportation. The new description reverts in large measure to the 1988 version, eliminating changes made in 1996.

Use of measures other than actual costs will require approval from the MMS. However, the agency said once a decision is made it will apply retroactively, noting that MMS now pays interest on overpayments. The rule also extends from two months to five months (recognizing the heating season) the period that the tariff exception can be used after the last reported arms-length transaction.

It also provides language clearly stating that allowances approved prior to 1988, which some have claimed are grandfathered, are no longer valid.

The MMS also was miffed that Order 2004-A (Affiliate Rule) issued by the Federal Energy Regulatory Commission (FERC) made it difficult for a producer to know the transportation charges paid by arms length shippers to the producer's affiliated pipeline unless the pipeline makes the information public. "The MMS's requirement to use actual costs pre-dates the new FERC information-sharing restrictions, and no one either protested the order on this ground or informed MMS that the order would interfere with compliance with the federal gas valuation rule." MMS said it intends to petition FERC for a declaratory order to allow a pipeline to share transportation charge information with its affiliate and the MMS in order to compute the transportation deduction.

The final amendments add a provision to allow for future valuation agreements between the MMS and a lessee. This provision is intended to provide flexibility to both MMS and the lessee in those few unusual circumstances where an individual written agreement is needed. Any such agreement must at least approximate the royalty value for the production that would apply under the regulations.

The MMS said the amendments to the 1988 Federal Gas Valuation Rule will make federal natural gas leases more attractive for development, and provide assurance of a fair market return on these resources to the American public, The final amendments to the rule, used to determine royalties due on natural gas from federal leases, were published March 11.

The federal agency put aside the question once again of whether published spot gas indexes could be used to value royalty gas, saying it received conflicting comments on the issue. Currently, the rules state gas sold not at arms-length should be valued according to comparable arms-length sales of like quantities. If there are no comparable sales available, indexes or other information may be used, but it must be approved by the MMS. One objection to the use of indexes is the fact that the surveys include nonarms-length transactions, MMS said.

The final amendments modify the definition of arm's-length contract and also add a definition of the term affiliate to be consistent with a recent court decision and changes to the oil valuation rule in 2000. An arms-length contract refers to a contract between two independent companies that are not affiliated and that have opposing economic interests regarding that contract.

MMS held a series of public workshops in April and May of 2003 to gather feedback on possible revisions to the 16-year-old rule. Based on feedback from the workshops, MMS published a proposed rule on July 23, 2004. The comment period on the proposed rule closed Sept. 21, 2004.

The rule can be viewed online at: www.mrm.mms.gov.

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