The United States District Court for the District of Columbiahas struck down a controversial part of the Interior Department’s1997 royalty valuation rule for natural gas, which incorporatedmarketing costs in the valuation. (Civ. No. 98-00531)
In granting the summary judgment requested by the IndependentPetroleum Association of America and the American PetroleumInstitute, Judge Royce C. Lamberth found no basis for the InteriorDepartment’s Minerals Management Service (MMS) to claim producershad an “implied duty to market” at no cost to the government. “Theend result of the rule is that lessees must now pay a royalty inexcess 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 ofvarious affected MMS departments, including its auditors, late lastweek to start the process of determining a course of action. “Itwon’t be in the next week or so, but it won’t take 60 days,” Thedecision did not specify and the MMS at this point does not knowwhether refunds would be required. “But, we felt we had to let theauditors know,” she said. Producers have been complying with therule since 1997.
The judge confessed to a basic skepticism about the provision.”.If such an implied duty were so widely recognized andlongstanding, common sense suggests that there would be no need towrite it in at this late date.” What is well-recognized is that”the government’s royalty interest is limited to the value ofproduction at the lease or wellhead, not in value enhancementsresulting from downstream activities.
“The court finds untenable MMS’ present position that it has theauthority to define value to include downstream costs unrelated toproduction of the gas,” the judge said in the opinion issued March28.
Lamberth went on to say the rule “simply labels certain costsmarketing and certain costs transportation, without offering anyconsistent or principled justification for why a particular labelapplies.” For instance storage costs for over 30 days aredeductible from a valuation, while storage costs for less than 30days are not.
“Upholding the rule by endorsing MMS’ interpretation of theleases and regulations would place no logical limits on MMS’authority to rewrite the leases to the detriment of the lessees andthe direct pecuniary benefit of the government.”
The rule disallows deductions for marketing costs for aggregatoror marketing services fees, as well as firm transportation demandcharges for unused capacity and intra-hub title transfer fee. Itallows deductions for transportation costs, which include gassupply realignment costs, Gas Research Institute fees, AnnualCharge Adjustment fees, commodity charges, wheeling costs andlong-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 allconsumers of natural gas,” Barry Russell, IPAA president, said. “Itblocks the government from imposing on producers and consumers anartificial tax on the transportation of gas between the wellheadand the burner tip.”
The court ruling has implications for another rule applying tocrude oil valuation issued by the Interior Department earlier thismonth. “Both rules are based on the view that the government shouldreceive a free ride on the backs of producers when they move oiland 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 heldthat duty does not exist.”
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