The Independent Petroleum Association of America (IPAA) and the American Petroleum Institute (API) separately petitioned an appeals court in Washington, DC, last week to review its earlier decision upholding the federal government’s right to include downstream marketing costs when computing natural gas royalties owed by individual producers.

At issue is a February decision from the U.S. Court of Appeals for the District of Columbia that overturned a producer-favorable ruling issued by the federal court in DC in 2000. The 2000 decision declared illegal a controversial portion of the Interior Department’s 1997 royalty valuation rule for natural gas, which required marketing costs to be included in the “gross proceeds” amount upon which royalties are assessed on federal lands.

“On the deductibility of marketing costs, we find no legal error in Interior’s rule and, therefore, reverse the [DC] district court,” the appellate panel said in its ruling last month. “We find nothing unreasonable in Interior’s refusal to allow [producer] deductions for so-called ‘downstream’ marketing costs.”

Attorneys for the API and IPAA, which jointly represented producers in the case, drew a distinction between marketing costs for sales at the lease and marketing costs for sales downstream of the lease. While the two groups did not challenge the deductibility of the former, they argued that producers should be permitted to deduct the latter from the royalty-bearing proceeds amount.

The appellate court, however, failed to appreciate the argument. In its petition for review, the API argued that the court “[was] wrong in rejecting [this] distinction between marketing costs incurred in sales at the lease and downstream marketing costs. The distinction is firmly grounded in the statute.”

While the distinction had “little practical significance when producer/lessees sold gas at the wellhead, it is of fundamental importance in the aftermath of changes in FERC policy that unbundled interstate pipeline services and allowed producer/lessees to compete for sales in downstream markets,” the API said.

By increasing the royalty burden of gas marketed away from the lease, API contends the court’s ruling “undermines the pro-competitive policies of the FERC,” and “chills the entrepreneurial efforts of producers/lessees to compete in the downstream gas markets that the Commission sought to open by its unbundling initiatives under Order 636.”

In seeking review, the IPAA “is advancing different arguments [than API], but for the same purpose,” said IPAA attorney L. Poe Leggette. He noted, however, he expects API’s and IPAA’s petitions for review to be eventually combined.

The API and IPAA petitions do not address the part of the appellate court’s ruling that upheld a producer’s right to exclude firm transportation demand charges for unused capacity from royalty consideration. The appellate court had affirmed the federal court’s decision on this score.

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