After a two-month investigation, the Department of Justice fileda lawsuit last week against affiliates of ExxonMobil and BurlingtonResources for “knowingly underpaying” natural gas royalties forproduction from federal and Indian lands. Justice also requestedmore time to decide whether to sue Shell Oil and Meridian Oil forsimilar violations.

The actions were taken in U.S. District Court for the EasternDistrict of Texas in Lufkin, TX, following an investigation promptedby several civil suits filed by three industry whistle-blowers overthe past two years (see NGI, April 10).

In its complaint, Justice said that beginning in 1991 foroffshore production and in 1993 for onshore production the Mobilaffiliates (now ExxonMobil) changed the pricing methodology used inroyalty calculations and came up with a “transfer price” using anadjusted index that was based on prices that were “too low and didnot constitute a reasonable value for Mobil’s natural gas under anyof the applicable benchmarks.”

In calculating the adjusted indexes, Justice claims, Mobilincluded indexes to potential markets that Mobil did not actuallyserve. Although its gas went to the most profitable markets,Mobil’s transfer price, which is used in calculating royalties, wasbased on prices at less profitable markets. Justice also claimsMobil consistently received above-index prices for its gas butfailed to use those prices in its royalty calculations. Inaddition, it claims that Mobil artificially increased certaintransportation deductions, using maximum transportation rates whenit actually paid discounts, in order to come up with a lowertransfer price on which to calculate its royalties.

In Burlington’s case, Justice said between 1988 and 1998 theproducer used “sham intermediate transactions to avoid payingroyalties on the full sales price received from third parties underarms-length contracts. Rather than sell directly to third parties,Burlington’s production subsidiaries first sold the gas toBurlington Trading at the Burlington transfer price.” The actual”arms-length” sales to a third party by its affiliate drew muchhigher prices.

In addition, the transfer price that was used was based on”estimated” index prices, indexes that were “biased downward” orindexes that did not reflect Burlington’s actual disposition ofgas. “At all times relevant to this proceeding, the Burlingtontransfer price undervalued the Burlington defendants natural gasand NGLs for royalty computation purposes because it was calculatedusing prices that were too low and deductions for transportation,processing and treating that were either unallowable orexcessive..,” Justice said.

The producer affiliates all deny they underpaid royalties ontheir gas production. “It’s our position that we have paid allthese royalties in a fair and proper manner and in completeaccordance with the federal regulations and the provisions of thecompany contracts with the federal government,” said ExxonMobilspokesman Bob Davis. “It’s also our position that the government’sclaims in these cases are simply an attempt to unilaterally changethe terms of the contracts and usurp the administrative process setup by the [Minerals Management Service] and the agreements thathave been entered into by the MMS and ExxonMobil.

“A federal court in the District of Columbia rejected the theorythat’s being set forth by the federal government in these cases,”said Davis. “And we expect it to be rejected here as well. See theIPAA versus Armstrong case,” he said. In that case the UnitedStates District Court for the District of Columbia struck down acontroversial part of the Interior Department’s 1997 royaltyvaluation rule for natural gas, which incorporated marketing costsin the valuation (Civ. No. 98-00531). In granting the summaryjudgment requested by the Independent Petroleum Association ofAmerica and the American Petroleum Institute, Judge Royce C.Lamberth found no basis for the Interior Department’s MineralsManagement Service (MMS) to claim producers had an “implied duty tomarket” at no cost to the government. “The end result of the ruleis that lessees must now pay a royalty in excess of the value ofproduction they received from the sale,” Lamberth said in declaringthat part of the rule invalid (see NGI, April 3, 2000 and March 9, 1998).

“We feel that ultimately when this case is reviewed, [the IPAAvs. Armstrong case] will work certainly to ultimately reject theDOJ’s theory,” said Davis.

Davis also noted that Mobil recently won a landmark oil royaltydecision in the Long Beach case in which the city of Long Beachaccused the producer of underpaying royalties using methods similarto those in the current case. The Long Beach case had gone on for10 years.

There are “hundreds” of these “qui tam” cases, in whichwhistle-blowers, usually disgruntled former employees, drum upcharges against producers in the hopes of winning a sizablepercentage of the damages if the case is won, noted one producerofficial, who asked to remain anonymous.

Qui tam, which is Latin for “he who sues on behalf of the kingas well as for himself,” is a provision of the Federal Civil FalseClaims Act that allows a private citizen to file a suit in the nameof the U.S. Government charging fraud by government contractors andother entities who receive or use government funds, and share inany money recovered. Before a 1986 amendment, the court couldarbitrarily set the percentage of award for the qui tam relator.The 1986 amendment guaranteed a minimum of 15% of the recovery anda maximum of 30% for the relator to aid in paying an attorney andspending the time and money on the case.

“For a lot of these people it’s like an attempt to win thelottery,” the producer said. “Having the government on their sidehelps a lot. But just because the government gets involved does notcause a presumption of guilt. There are many other qui tam casesthat have arisen as a result of this whole issue where someonecomes in and says ‘well the company has not made the properpayments and has manipulated transportation costs or indexing.’There’s a very strong financial incentive for them to make thoseclaims.”

For example the two whistle-blowers who won a settlement inApril with BP and Amoco after filing a complaint under the FalseClaims Act will share more than $5.4 million of the settlementproceeds. Earlier this year, Mobil, BP Amoco and others shelled outbig bucks to settle whistle-blower claims for underpayment ofroyalties on oil production. BP Amoco agreed to pay a total of $32million as part of the settlement with the Department of Justiceand the whistle-blower. Mobil paid $45 million, Oxy USA Inc. paid$7.3 million, Chevron shelled out $95 million and Conoco added $26million.

There are three other cases currently in which the Department ofJustice has intervened. So far, Justice has decided to file onlyone complaint in the suit against ExxonMobil and Burlington. Inthat case the whistle-blower is a former Mobil employee who said hehad “personal and direct knowledge of Mobil’s fraudulent andunlawful conduct” to “shortchange” the federal government of”millions of dollars” in gas royalties [Case No. 1-99CV-416].

Justice is contemplating other complaints, however. This couldbe just the tip of the iceberg. In one of the three cases, awhistle-blower accused 131 production-related companies ofdefrauding the federal government, states and Indian tribes of”billions of dollars” in royalties on natural gas and natural gasliquids [Case No. 9-98CV30]. This was accomplished, thewhistle-blower alleged, through “coordinated and common fraudulent’skimming’ devices and schemes and conspiracies by Exxon Corp. andsome of the other largest energy companies in the world…” (seeNGI, April 10).

Rocco Canonica

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