Valuation of Oil and Gas From Indian Leases

DEPARTMENT OF THE INTERIOR

Minerals Management Service

30 CFR Part 206

RIN 1010-AB57

Valuation of Oil and Gas From Indian Leases

AGENCY: Minerals Management Service (MMS), Interior.

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: The Minerals Management Service (MMS) is considering amending

its regulations regarding the valuation of gas produced from Indian

leases to ensure that Indian mineral lessors receive the maximum

revenues from mineral resources on their land consistent with the

Secretary of the Interior's (Secretary) trust responsibility and lease

terms.

Most Indian leases provide that the value of production for royalty

purposes be determined by the Secretary. In making this determination,

the Secretary must consider his trust responsibility. In the exercise

of this responsibility, value in the discretion of the Secretary may be

determined by taking the highest of several values. This notice

describes several alternatives to establish these values and solicits

comments before publishing proposed new regulations governing the value

of gas production from Indian lands.

The MMS is not currently proposing changes to the oil valuation

regulations for Indian leases. The MMS may consider changes following

study of oil valuation for Indian leases.

DATES: Comments must be received on or before October 3, 1994.

ADDRESSES: Written comments, suggestions, or objections regarding

alternative valuation methods should be mailed to the Minerals

Management Service, Royalty Management Program, Rules and Procedures

Staff, Denver Federal Center, Building 85, P.O. Box 25165, Mail Stop

3101, Denver, Colorado 80225-0165, Attention: David S. Guzy, telephone

(303) 231-3432.

FOR FURTHER INFORMATION CONTACT:

David S. Guzy, Chief, Rules and Procedures Staff, MMS Royalty

Management Program at (303) 231-3432.

SUPPLEMENTARY INFORMATION:

I. Background

All Indian leases contain provisions for the determination of

royalty obligations. Some Indian leases or agreements negotiated under

the 1982 Indian Mineral Development Act contain explicit methodologies

for determining royalty obligations. The MMS does not intend to alter

these express valuation methodologies.

Most Indian leases were entered into under the authority of earlier

statutes, and these leases reserve to the Secretary considerable

discretion in determining value for royalty purposes. This Advance

Notice of Proposed Rulemaking is intended to solicit comments on new

methodologies being considered to establish value for these leases.

Comments that are received in response to this Advance Notice will be

considered in the development of a proposed rulemaking that will be

published in the Federal Register at a future date.

Most Indian leases also provide that royalty obligations be based

on the value of hydrocarbon substances produced and saved. A royalty

obligation is incurred when hydrocarbon substances are produced and

saved and not solely as the result of a sale.

Section 3(c) of a standard Indian lease covers leasee rental and

royalty payment requirements and states:

(c) Rental and royalty. To pay, beginning with the date of

approval of the lease by the Secretary of the Interior or his duly

authorized representative, a rental of $1.25 per acre per annum in

advance during the continuance hereof, the rental so paid for any

one year to be credited on the royalty for that year, together with

a royalty of 16\2/3\ percent of the value or amount of all oil, gas,

and/or natural gasoline, and/or all other hydrocarbon substances

produced and saved from the land leased herein, save and except oil,

and/or gas used by the lessee for development and operation purposes

on said lease, which oil or gas shall be royalty free. During the

period of supervision, ``value'' for the purposes hereof may, in the

discretion of the Secretary, be calculated on the basis of the

highest price paid or offered (whether calculated on the basis of

short or actual volume) at the time of production for the major

portion of the oil of the same gravity, and gas, and/or natural

gasoline, and/or all other hydrocarbon substances produced and sold

from the field where the leased lands are situated, and the actual

volume of the marketable product less the content of foreign

substances as determined by the oil and gas supervisor. The actual

amount realized by the lessee from the sale of said products may, in

the discretion of the Secretary, be deemed mere evidence of or

conclusive evidence of such value. When paid in value, such

royalties shall be due and payable monthly on the last day of the

calendar month following the calendar month in which produced; when

royalty on oil produced is paid in kind, such royalty oil shall be

delivered in tanks provided by the lessee on the premises where

produced without cost to the lessor unless otherwise agreed to by

the parties thereto, at such time as may be required by the lessor:

Provided, that the lessee shall not be required to hold such royalty

oil in storage longer than 30 days after the end of the calendar

month in which said oil is produced: And provided further, that the

lessee shall be in no manner responsible or held liable for loss or

destruction of such oil in storage caused by acts of God. All rental

and royalty payments, except as provided in section 4(c) shall be

made by check or draft drawn on a solvent bank, open for the

transaction of business on the day the check or draft is issued, to

the payee designated by the Area Director. All such rental and

royalty payments shall be mailed to the oil and gas supervisor for

transmittal to the payee designated by the Area Director. It is

understood that in determining the value for royalty purposes of

products, such as natural gasoline, that are derived from treatment

of gas, a reasonable allowance for the cost of manufacture shall be

made, such allowance to be two-thirds of the value of the marketable

product unless otherwise determined by the Secretary of the Interior

on application of the lessee or on his own initiative, and that

royalty will be computed on the value of gas or casinghead gas, or

on the products thereof (such as residue gas, natural gasoline,

propane, butane, etc.), whichever is the greater.

In conjunction with the lease terms, the valuation of gas

production from Indian leases is subject to the regulations at 30 CFR

Part 206. The present regulations govern the valuation of production

from both Federal and Indian (Tribal and allotted) leases (except

leases on the Osage Indian Reservation, Oklahoma) (Revision of Gas

Royalty Valuation Regulations and Related Topics; Final Rule, published

in the Federal Register on January 15, 1988 (53 FR 1230).

MMS now believes that it may be able to better perform the trust

responsibilities of the United States with respect to the

administration of Indian oil and gas leases by issuing separate

regulations for the valuation of gas from these leases. Also, MMS

believes that it could provide an improved regulatory framework in

which these lease terms can be strictly enforced while economizing on

the information needed by a lessee. MMS is seeking to adopt valuation

procedures that could be compiled with by the lessee in a timely

manner.

The Secretary is obligated to act as a fiduciary in the

administration of Indian oil and gas leases. As a fiduciary, charged

with supervising the disposition of nonrenewable resources from Indian

lands, the Secretary must ensure that Indians receive the maximum

revenues from mineral resources on their lands. To ensure maximum

revenues, the value of production for royalty purposes from an Indian

lease should be determined considering the highest values provided by

the terms of the standard lease, quoted above. MMS believes this is

consistent with the terms of these Indian oil and gas leases, with

statutes delegating to the Secretary the administration of Indian

affairs, with the statutes governing Indian oil and gas leases, with

the Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA), with

court decisions providing judicial guidance in the interpretation and

administration of Indian oil and gas leases, and with the law of trusts

and fiduciary operations.

MMS has considered that maximizing royalty revenues from Indian

leases might affect the economics of mineral resource development and

believes that this should not result in the reduction of the value of

production for royalty purposes. This issue should be examined in the

context of an adjustment of lease terms by the Bureau of Indian Affairs

and the Indian lessor.

II. Current Regulations

The current valuation regulations incorporate the terms of the

standard Indian leases in the ways listed below.

(a) The value of production is never less than the gross proceeds

accruing to the lessee. This provision is contained in valuation

regulations at 30 CFR 206.102(h), 206.152(h), and 206.153(h), which

state:

Notwithstanding any other provision of this section, under no

circumstances shall the value of production, for royalty purposes,

be less than the gross proceeds accruing to the lessee for lease

production, less applicable allowances determined pursuant to this

subpart.

(b) The value of production will be the higher of the major portion

value and the otherwise applicable value. This provision is contained

in valuation regulations at 30 CFR 206.102(a)(2)(i), 206.152(a)(3)(i),

and 206.153(a)(3)(i), which state:

For any Indian leases which provide that the Secretary may

consider the highest price paid or offered for a major portion of

production (major portion) in determining value for royalty

purposes, if data are available to compute a major portion, MMS

will, where practicable, compare the value determined in accordance

with this section with the major portion. The value to be used in

determining the value of production, for royalty purposes, shall be

the higher of those two values.

(c) The value of production will be the greater of (1) the combined

value, for royalty purposes, of the residue gas and gas plant products

resulting from processing the gas, or (2) the value, for royalty

purposes, of the gas prior to processing determined in accordance with

30 CFR Secs. 206.152 and 206.155.

III. Discussion

The Secretary's responsibility to determine value for royalty

purposes of production from Indian lands has not changed, although the

industry and marketplace have changed dramatically over the years. One

of the objectives MMS hopes to achieve is to develop a set of

regulations to permit the Secretary to discharge this responsibility in

an environment of continuing and accelerating change in the industry

and the marketplace. The trust responsibility of the Secretary and the

changing marketplace require that the Secretary develop flexible

valuation methodologies for Indian production that can be complied with

accuracy and on time. MMS seeks to improve several areas of Indian gas

valuation including: major portion analysis, accounting for comparison

(dual accounting), and Percentage-of-Proceeds (POP) contracts.

Following is a discussion of each of these areas.

(a) Major Portion Value

Section 3(c) of most Indian leases provides that value may be based

on the highest price paid or offered for a major portion of oil or gas

or similar substances. Many lessees have stated that there are

difficulties encountered in complying with major portion valuation

requirements and the timeliness of major portion analyses performed by

MMS.

Indian mineral owners assert the median pricing methodology in the

present regulations does not always achieve the highest price paid for

a major portion of production provided by the lease terms. Since the

Secretary has considerable discretion in establishing value for royalty

purposes, the Secretary has been urged to be more flexible in

establishing major portion methodologies.

(b) Dual Accounting

Section 3(c) of most Indian leases provides for ``dual

accounting''--the requirement to pay royalties on the greater of the

combined value of the residue gas and plant products resulting from

processing the gas or the value of the gas prior to processing. Dual

accounting is required whether gas is sold prior to processing or after

processing. In either case, the lessees may have difficulty in

gathering the data necessary to comply, which delays the proper payment

of royalties to the Indian lessors. Improvement in the regulations that

will permit lessees to timely and completely comply with the lease's

dual accounting requirement is desirable.

(c) Percentage-of-Proceeds (POP) Contracts

This class of contracts for the sale of gas from Indian leases

presents a different problem in determining value for royalty purposes.

Under a POP contract, the seller is paid based upon a value determined

after processing. As the name given to this class of contract suggests,

the seller is paid an agreed-upon percentage of the purchaser's

proceeds from the sale of residue gas and usually a different and much

smaller percentage of the proceeds from the sale of gas plant products.

Lessees have objected to the dual accounting requirement for gas sold

pursuant to a POP contract because of a lack of wellhead sales.

Regulations that permit lessees to timely and accurately comply with

POP contract valuation requirements are desirable.

In summary MMS's goal is to develop simplified methods for

determining the highest price paid or offered for a major portion of

like-quality production from the field or area, for determining the

greater of the processed value or the unprocessed value, and for

properly valuing POP contract production, on a more contemporaneous

basis. This would simplify the accounting and enhance the

administrative workability for both Tribal and MMS royalty personnel as

well as the oil and gas industry. It would allow more contemporaneous

automated accounting comparisons and reduce the reliance on audits

conducted years after production occurs to verify royalty compliance.

IV. Description of Alternatives and Solicitation of Comments

MMS invites specific comments on the following alternatives that is

currently considering for valuation under the major portion and dual

accounting requirements for gas produced, saved, or sold from tribal

and allotted Indian Lands.

(a) Major Portion Scenarios

(1) Use of Gas Price Indices

MMS is considering using published indices of natural gas prices as

a means to determine the price at which a major portion of gas is sold

from a given field or area. It is contemplated that any index or

indices used would be widely used by industry, have a history of

publication, and generally be expected to continue to be published. It

is likewise contemplated that any regulation that uses published

indices would provide for the use of substitute indices if necessary.

MMS is aware that gas-index-price-based major portion systems are

currently being successfully utilized.

MMS is soliciting comments on what publications are most widely

used by industry for gas price indices. MMS also seeks input from

companies that are successfully using gas price index-based formulas to

determine the major portion value, and the ways the gas price indices

are used to arrive at a value. MMS is also particularly interested in

perspectives regarding the extent to which published prices reflect

actual values of production, and perspectives regarding the accuracy of

published prices and indices.

MMS would also appreciate comments on the extent to which the use

of published prices would promote: The certainty and reliability of

payments, the timeliness of royalty reporting, ease of compliance,

enforceability, and the reduction of costs to both industry and

government.

(2) Major Portion Analysis Using Price Data Reported to Indian Tribes

and States.

MMS has used gas prices obtained from the Oklahoma Tax Commission

severance tax report to do a major portion calculation for allotted

Indian leases in the Anadarko area of Oklahoma. MMS requests comments

on the feasibility of MMS doing the major portion calculation using

pricing data obtained from Tribes, States, or other outside sources

(that have information available).

(3) Major Portion Analysis Using Price Data Reported on the Report of

Sales and Royalty Remittance (Form MMS-2014).

Information reported on Form MMS-2014 has been used to do major

portion calculations for gas produced from the Southern Ute Tribal and

Allotted Indian leases. MMS requests comments on the feasibility of MMS

calculating the major portion price from data on Form MMS-2014.

(4) Requirement That All Purchasers Provide Sales Data to MMS

MMS is considering implementing a new regulation (under the

authority of FOGRMA) that would require all purchasers of Federal and/

or Indian gas in fields or areas in which Indian production occurs to

provide volume and pricing data to MMS. MMS would then calculate major

portion prices and provide these to the lessees. MMS seeks comments on

the feasibility of such an approach.

(5) Flexibility To Negotiate a Method to do a Major Portion Analysis on

a Case-By-Case Basis

MMS is considering adding new regulatory language that would allow

lessees the flexibility to negotiate with Indian Tribes and allottees a

method of fulfilling the value of a major portion of production from a

field or area. MMS seeks comments on the feasibility of such an

approach.

(b) Dual Accounting Scenarios

(1) Wellhead Sale of Gas and the Gas Is Processed (Seller Not Owner in

Gas Plant)

Under this scenario, the lessee typically sells gas prior to

processing in a gas plant. The lessee should know the gross proceeds

accruing under the sale of gas at the wellhead. To fulfill the dual

accounting requirement, the lessee is also required to obtain the

actual sales values of the residue gas and gas plant products after

processing. Lessees have made MMS aware of the difficulty, in some

instances, in obtaining all of the information necessary to determine

accurately the value of production. On July 27, 1992, MMS issued a

letter to payors describing a theoretical dual accounting method that

can be used to approximate the value of gas after processing. Although

this method has helped, MMS has been made aware that there are still

problems in obtaining information that is both timely and accurate.

To facilitate the process of obtaining all of the information (such

as gas plant efficiencies, processing charges, plant fuel and flare

volumes, and fractionation costs) necessary to accurately do dual

accounting, MMS is considering the following alternatives:

MMS could draft regulations requiring owners of plants

that process Federal and/or Indian gas to report the processing

information directly either to MMS, the lessee, or both.

MMS could attempt to obtain information on plants that

process Indian gas from State agencies.

MMS requests comments on the feasibility of requiring plant owners

to make processing information available to lessees or MMS. MMS also

welcomes suggestions for any other possible alternatives for obtaining

this information.

MMS is also considering establishing a single basin-wide processing

allowance that would be used by all lessees or could be used when the

lessee does not have actual processing plant information. MMS requests

comments on using basin-wide allowances that the MMS would periodically

calculate and publish.

(2) Gas Is Sold at the Tailgate of a Gas Plant

In this situation, the lessee should have all of the data

pertaining to the sale of the processed gas. To fulfill the dual

accounting requirement, the lessee must determine the value of the

unprocessed gas at the wellhead. When there is no sale of gas at the

wellhead, the wellhead unit value ($/MMBtu) of the gas for royalty

purposes could be determined by using: (1) Gross proceeds under arm's-

length contracts for like-quality gas in the same field or nearby

fields or areas; (2) the unit value of the residue gas; (3) gas price

indices posted in publicly available national publications; or (4) the

price arrived at by performing a major portion analysis.

MMS seeks comments on the availability of information and the

accuracy of the above methods in determining the value for royalty

purposes of unprocessed gas at the wellhead. MMS further seeks comments

on what specific publications are used by industry for index prices.

MMS also seeks comments on using the highest price in the range, the

index price, the average price, or some combination of prices if index

pricing were used in dual accounting.

(3) Gas Is Sold Under a POP Contract

MMS requests comments on the following methods of determining value

of gas at the wellhead under a POP contract when doing dual accounting:

(i) Gross proceeds under the POP contract,

(ii) The unit value of the residue gas,

(iii) Gas price indices posted in publicly available national

publications,

(iv) The price arrived at by performing a major portion analysis;

and

(v) Prices received under arm's-length wellhead sales in the field

or area.

MMS also seeks suggestions on other possible methods to arrive at a

value of unprocessed gas at the wellhead for comparison purposes under

dual accounting.

(4) Percentage Increase to Value in Lieu of Dual Accounting

In situations where lessees have made a reasonable effort to do

dual accounting but nonetheless cannot establish an accurate comparison

of values, MMS is considering allowing a percentage increase to the

otherwise determined value of production in lieu of dual accounting.

Analysis has shown that the difference between the greater of the

combined value of the residue gas and plant products resulting from

processing the gas or the value of the gas prior to processing has

exceeded 40 percent of the lower value in some cases. MMS seeks

comments on the feasibility of applying a percentage increase and the

amount of such an increase to comply with dual accounting requirements.

(c) Integration of Major Portion Scenarios and Dual Accounting

Scenarios

MMS seeks comments on how to integrate any selected scenarios on

major portion with the scenarios on dual accounting. For example, one

way to integrate these is the following:

If the index scenario is selected for major portion analysis and

the percentage increase is selected for dual accounting, then a way to

integrate these concepts is to apply the percentage increase to the

higher of index or gross proceeds.

Dated: July 18, 1994.

Bob Armstrong,

Assistant Secretary for Land and Minerals Management.

[FR Doc. 94-19053 Filed 8-3-94; 8:45 am]

BILLING CODE 4310-MR-M