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Court Nixes Marketing Costs from Royalties

Court Nixes Marketing Costs from Royalties

The United States District Court for the District of Columbia has struck down a controversial part of the Interior Department's 1997 royalty valuation rule for natural gas, which incorporated marketing costs in the valuation. (Civ. No. 98-00531)

In granting the summary judgment requested by the Independent Petroleum Association of America and the American Petroleum Institute, Judge Royce C. Lamberth found no basis for the Interior Department's Minerals Management Service (MMS) to claim producers had an "implied duty to market" at no cost to the government. "The end result of the rule is that lessees must now pay a royalty in excess of the value of production they received from the sale," Lamberth said in declaring that part of the rule invalid.

The MMS has 60 days to decide whether to appeal the decision. A.B. Wade, MMS spokesperson, said there had been a meeting of various affected MMS departments, including its auditors, late last week to start the process of determining a course of action. "It won't be in the next week or so, but it won't take 60 days," The decision did not specify and the MMS at this point does not know whether refunds would be required. "But, we felt we had to let the auditors know," she said. Producers have been complying with the rule since 1997.

The judge confessed to a basic skepticism about the provision. ".If such an implied duty were so widely recognized and longstanding, common sense suggests that there would be no need to write it in at this late date." What is well-recognized is that "the government's royalty interest is limited to the value of production at the lease or wellhead, not in value enhancements resulting from downstream activities.

"The court finds untenable MMS' present position that it has the authority to define value to include downstream costs unrelated to production of the gas," the judge said in the opinion issued March 28.

Lamberth went on to say the rule "simply labels certain costs marketing and certain costs transportation, without offering any consistent or principled justification for why a particular label applies." For instance storage costs for over 30 days are deductible from a valuation, while storage costs for less than 30 days are not.

"Upholding the rule by endorsing MMS' interpretation of the leases and regulations would place no logical limits on MMS' authority to rewrite the leases to the detriment of the lessees and the direct pecuniary benefit of the government."

The rule disallows deductions for marketing costs for aggregator or marketing services fees, as well as firm transportation demand charges for unused capacity and intra-hub title transfer fee. It allows deductions for transportation costs, which include gas supply realignment costs, Gas Research Institute fees, Annual Charge Adjustment fees, commodity charges, wheeling costs and long-term storage costs.

IPAA and API had challenged the rule in cases brought in 1998.

"This is a great victory for independent producers and for all consumers of natural gas," Barry Russell, IPAA president, said. "It blocks the government from imposing on producers and consumers an artificial tax on the transportation of gas between the wellhead and the burner tip."

The court ruling has implications for another rule applying to crude oil valuation issued by the Interior Department earlier this month. "Both rules are based on the view that the government should receive a free ride on the backs of producers when they move oil and gas closer to market before selling it," said Poe Leggette, with Fulbright & Jaworski, who represented IPAA in the lawsuit. "Both rules are based on an implied duty to market. The court held that duty does not exist."

Ellen Beswick

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