The Minerals Management Service (MMS) recently determined that natural gas sales transactions between Chevron Corp. and Dynegy Inc. were “arm’s-length” and therefore not subject to collection of additional royalties as if they were “nonarm’s-length,” as the MMS had previously maintained.

The case involves the relationship between Chevron and Dynegy, to whom in 1996 Chevron sold holdings in more than 50 gas processing plants in exchange for a stake in the gas marketer’s business. Over the next seven years, Chevron sold virtually all of its domestic gas to Dynegy for processing.

MMS alleged in 2001 that Chevron underpaid royalties on the grounds that the company’s gas sales to Dynegy were nonarm’s length as the company had reported them. Chevron appealed and said that despite the fact that it now had a minority interest in Dynegy, the Chevron-Dynegy contract was arm’s length within the meaning of governing federal regulations.

In a modified order, the MMS agreed and cited a similar case involving Vastar Resources and Southern Company. In the Vastar case, the Interior Board of Land Appeals (IBLA’s) reversed the MMS and said that a gas sales contract between Vastar and Southern was arm’s-length in spite of the fact that Vastar owned 40% of Southern. In its modified order on the Chevron-Dynegy case, the MMS said the rationale of the IBLA decision also applied and that it must follow that precedent in deciding on Chevron-Dynegy.

In a written response to a request for comment from NGI, Chevron said, “Based on the regulations and decisions interpreting them, including Vastar Resources, Inc., 167 IBLA 17 (2005), the MMS found that Chevron’s ownership interest in Dynegy was insufficient to allow Chevron to control Dynegy and that opposing economic interests were present in their contracts.”

According to a Tuesday report in The New York Times, the MMS could have stood to collect more than $6 million in additional royalties from Chevron had it continued to pursue the case against the company. The MMS, which told Chevron of its decision in an Aug. 3 letter that The Times recently obtained through the Freedom of Information Act, could have sought tens of millions more had it prevailed in the case, said the paper, whose report was critical of the agency for not being more aggressive in its pursuit of royalties.

MMS responded to NGI in writing to a request for comment on the case and the report in The Times.

“MMS maintains an aggressive and comprehensive compliance program to ensure timely and correct payment of the nation’s mineral lease revenues,” the MMS response said. “Although MMS aggressively pursues issues in question, in some cases the courts have ruled against the MMS position. MMS must accept these rulings and act accordingly. Vastar was the first company to appeal the MMS order to the Interior Board of Land Appeals (IBLA), an appellate review body with nine administrative judges whose decisions are final for the Department of the Interior.

“The IBLA decision means Chevron will not have to pay any additional royalties beyond what it has already paid on its residue gas sales to Dynegy, for the period from 1996 through January 2003. It is important to note that MMS collected more than $1.2 billion in gas royalties from Chevron from 1996 through January 2003 on the leases in question, and more than $2.5 billion in royalties from all Federal and Indian leases held by Chevron during the same time period.”

Chevron also is among the producers involved in a controversy over Gulf of Mexico leases on which the federal government has lost royalty revenue due to the failure by MMS to include price thresholds in producer agreements signed in the 1990s (see Daily GPI, Sept. 13).

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