A federal court in Washington, DC, late last month deferred to the Interior Department's interpretation of which costs can be deducted when producers calculate royalties owed for the production of natural gas on federal lands.

The case involved a dispute between Devon Energy Corp. and Interior over the extent of the deductions that the independent producer could take for coalbed methane production in the Powder River Basin in Wyoming. Oklahoma City, OK-based Devon interpreted the allowable deductions to include the costs for dehydrating and compressing coalbed methane as part of its transportation costs.

Interior convened a royalty policy board in November 1995 to settle the matter, but it only intensified the dispute. Devon said the board's guidance permitted it to deduct the costs of dehydration and compression, provided they were incurred after the gas reached the central delivery point (CDP) and were necessary for transportation. Interior countered that the board's conclusions were ambiguous and, if interpreted as Devon viewed them, erroneous. The ruling was upheld by Interior in 2003, which prompted Devon to seek relief in the courts.

"Devon...claims that disallowing the post-CDP deductions for dehydration and compression costs is an unreasonable reading of the marketable condition regulation, and hence 'arbitrary, capricious, an abuse of discretion or otherwise not in accordance with law.' However, the judicial standard of reviewing with deference [to] an agency's interpretation of its own regulations prevents overturning" Interior's decision, said U.S. District Court Judge Louis F. Oberdorfer.

The court granted Interior's cross-motion for summary judgment, while denying Devon Energy's plea for summary judgment.

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