Following up on a series of public workshops, the Minerals Management Service (MMS) has issued a proposal for rules refinements governing the valuation for royalty purposes of gas produced from federal leases and is calling for comments on the proposed amendments affecting future valuation, transportation allowances and definitions and tariffs.
Comments on the proposal, published in the July 23 Federal Register, are to be submitted by Sept. 21. MMS estimated the net decrease in royalty revenue to the federal government under the rules changes would be a loss of $5.2 million, the net decrease to states would be 2.1 million, with the two adding up to a $6.9 million savings for industry.
The agency said it was withholding judgment on a “major valuation issue,” that is whether to allow the use of spot market index prices or Nymex prices for valuation of gas sold in non-arm’s-length transactions. MMS noted the disparity of comments and “concerns expressed at the workshops” about the index prices, saying it would not address the issue in the currently proposed amendments, but “for future consideration” it requested comments on: (1) whether publicly available spot market prices for natural gas are reliable and representative of market value of natural gas and should be considered by MMS as a means of valuing natural gas production that is not sold at arm’s length and, if so, (2) how should these spot market prices be adjusted for location differences between the index pricing point and the lease.
Mary Williams, manager of federal onshore oil and gas compliance, said MMS was hoping the Federal Energy Regulatory Commission, which has been studying spot market price indexes, would submit comments on the question.
In the proposed rule, the agency would continue to refine the definition of a transportation allowance that can be subtracted from the valuation of gas in non-arms-length transactions. The new description reverts in large measure to the 1988 version, eliminating changes made in 1996. It would state, “Transportation allowance means an allowance for the reasonable, actual costs of moving unprocessed gas, residue gas, or gas plant products to a point of sale or delivery off the lease, unit area or communitized area, or away from a processing plant. The transportation allowance does not include gathering costs.
Further dealing with the transportation allowance, MMS proposes to increase the allowed rate of return percentage used in calculating costs to 1.3 times the industrial rate associated with the Standard and Poor’s BBB bond rating, instead of using the straight BBB rate. The increase is based on a recent MMS economic study on pipeline costs of capital, which incorporated data from Ibbotson which showed pipelines’ cost of capital in 2003 was between 1.1 times the BBB bond rate and 1.5 times BBB.
The rate increase would not apply to processing costs since the MMS has yet to do a new study on those costs. However, it “welcomes comments, data and analysis” on the issue and based on information received could make a change in processing cost allowances in the final rule.
The proposal would simplify the rule for exceptions based on a government examined and approved tariff, setting the transportation allowance, not at the maximum tariff rate, but at the volume-weighted average of the arms-length rates charged to the non-affiliated shippers under the tariff. The proposed rule reiterates that allowances “grandfathered” when the 1988 valuation rule became effective are terminated.
Consistent with a court ruling, MMS proposes to allow the deduction of demand charges, whether the capacity is used or not, as part of the transportation allowance. However, parties must offset that with amounts gained from the release and sale of unused capacity and any payments received from the pipeline in the form of adjustments such as penalty refunds or rate case refunds.
The proposal would amend current regulations to allow the deduction of actual, but not theoretical line losses under non-arms-length transportation contracts, unless the contract is governed by a government-approved tariff that includes a payment for theoretical line losses.
In arm’s-length transactions, MMS would allow deduction from the gas valuation of the cost of obtaining a letter of credit required by a pipeline to move gas on its line, and includes a formula for ascribing costs.
MMS also proposes amendments to exclude other costs from transportation allowances:
Some of the proposed rule changes would align the gas valuation rule with changes made in 2000 to the crude oil royalty valuation regulations, including a new definition of the term “arms-length contract” and the addition of a definition of the term “affiliate.”
The affiliate definition would automatically apply to parties with more than 50% common ownership. If ownership is more than 10% and less than 50%, then MMS would consider the extent of common officers or directors, whether there are other comparable ownership voting blocks and the extent of operations participation by other owners in a lease, plant, pipeline or other facility. It also would consider whether there is other evidence of the power to exercise control.
If a related entity has less than a 10% ownership share, there is a rebuttable presumption that it does not meet the definition of an affiliate. Regardless of ownership shares, blood relatives would be considered affiliates.
An “arms-length contract” would be one between non-affiliates who have opposing interests regarding the contract.
Copies of the proposal are available at https://www.mrm.mms.gov/Laws_R_D/FRNotices/PDFDocs/43944.pdf.
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