Amendments to Gas Valuation Regulations for Federal Leases

DEPARTMENT OF THE INTERIOR

Minerals Management Service

30 CFR Parts 202, 206, and 211

RIN 1010-AC02

Amendments to Gas Valuation Regulations for Federal Leases

AGENCY: Minerals Management Service, Interior.

ACTION: Notice of reopening of public comment period.

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SUMMARY: The Minerals Management Service (MMS) is reopening the public

comment period under a proposed rule published in the Federal Register

on November 6, 1995, amending the regulations governing the valuation

for royalty purposes of natural gas produced from Federal leases (60 FR

56007). In the December 13, 1995, Federal Register we extended the

comment period through February 5, 1996 (60 FR 64000). Based on the

diversity of comments received under the proposed rule, in this notice

we are publishing a summary of those comments, outlining five options

for proceeding with further rulemaking, and requesting public comment

on the five options.

DATES: Comments must be submitted on or before July 22, 1996.

ADDRESSES: You must send comments to: David S. Guzy, Chief, Rules and

Procedures Staff, Minerals Management Service, Royalty Management

Program, P.O. Box 25165, MS 3101, Denver, Colorado 80225-0165,

telephone (303) 231-3432, fax (303) 231-3194, e-Mail David__

G[email protected], courier delivery to building 85, Room A-212, Denver

Federal Center, Denver, CO 80225.

FOR FURTHER INFORMATION CONTACT: David S. Guzy, Chief, Rules and

Procedures Staff, Minerals Management Service, Royalty Management

Program, telephone (303) 231-3432, fax (303) 231-3194, e-Mail

David__G[email protected].

SUPPLEMENTARY INFORMATION:

I. Background

On June 27, 1994, in response to the Vice President's National

Performance Review, the Secretary chartered the Federal Gas Valuation

Negotiated Rulemaking Committee (Committee) for the purpose of

improving the regulations that govern the valuation, for royalty

purposes, of gas produced from Federal leases. The Committee was

comprised of representatives from large oil and gas companies,

independents,

[[Page 25422]]

trade associations, States, and MMS. We asked the Committee to address

the valuation and reporting of gas from approved Federal unit and

communitization agreements and the valuation of gas sold under non-

arm's-length contracts. We later expanded the charter of the Committee

to include the valuation of gas sold under arm's-length contracts in a

post-Federal Energy Regulatory Commission Order No. 636 marketing

environment. Other issues, such as allowable gathering and compression

deductions, transportation allowance determinations, transportation and

processing allowance forms, and dual accounting, also were the subject

of the Committee's attempt at streamlining and simplifying the

procedures for valuing Federal gas.

On November 6, 1995, we published a proposed rule reflecting the

consensus decisions of the Committee that would amend the regulations

governing the valuation of Federal gas. The amendments would add

several alternative valuation methods to the existing regulations. The

amendments would allow lessees to choose from several options for

valuing gas for royalty purposes, including for example published index

prices, affiliated companies' arm's-length resale prices, and residue

gas prices applied to the wellhead. The amendments would eliminate

several administrative functions such as allowance form filing and

accounting for comparison, also known as ``dual accounting'' as well as

redefine specific terms to provide certainty regarding their

deductibility from royalty. The amendments would also clarify who is

responsible for reporting and paying royalties on gas produced from

approved Federal agreements containing a mix of leases with different

lessors, royalty rates, or funds recipients, so called ``mixed

agreements''.

While the proposed rule reflected the consensus decisions of the

Committee, we received many comments opposing the proposed valuation

alternatives and the reporting and payment requirements for mixed

agreements. Many of the comments focused on the complexity of the rule

that arose from trying to develop options for valuing gas sold under an

array of marketing environments. While many comments were supportive of

allowing various options, clarifying terms, and eliminating certain

administrative burdens, we received a significant number of comments

that raise concerns about whether we should proceed in publishing a

final rule based on the consensus of the Committee.

We also received comments on five specific issues associated with

the proposed amendments for which comments were requested:

1. How should we improve the benchmarks (at 30 CFR Sec. 206.152(c)

and 206.153(c)) for valuing gas sold under non-arm's-length contracts

when the gas is not subject to the alternative valuation methods?

2. Should we require royalties on amounts received by lessees using

index-based valuation for gas contract settlements entered into after

the effective date of the rule?

3. What should be the consequences if we do not publish the final

safety net median value (as defined in the November 6, 1995, Federal

Register Notice) within 2 years after the end of the relevant calendar

year?

4. How should we process a credit for royalties paid on volumes in

excess of the volume a lessee is entitled to take from a mixed

agreement during the relevant calendar year?

5. How should we address the additional reporting on the Report of

Sales and Royalty Remittance (Form MMS-2014) that would be necessary to

implement the proposed rule?

II. Summary of Public Comments

We received comments from 44 entities, including independents,

major oil and gas companies, trade associations, States, a royalty

owner, and a pipeline company. Below is a summary of those comments. On

January 22, 1996, we held a public meeting to receive verbal comments

on the proposed rule. Five industry participants provided verbal

comments that were consistent with the written comments submitted by

their companies or trade associations. We have a transcript of those

comments available for review. If you are interested in reviewing

either the written comments in full or the transcript of the public

meeting, you may contact David S. Guzy, Chief, Rules and Procedures

Staff, Minerals Management Service, Royalty Management Program,

telephone (303) 231-3432, fax (303) 231-3194, e-Mail David__

G[email protected]. A complete set of the public comments is also

available on the Internet at www.rmp.mms.gov.

Independents (24 Commenters)

In general, most independents opposed index pricing as a valuation

alternative. They claimed its complexity discriminates against them

from a competitive standpoint. They also feared that index-based

valuation would lead to it becoming a minimum for royalties in excess

of gross proceeds. They pointed out that gross proceeds should be

acceptable and that the rule should state so explicitly.

A form letter was submitted by 17 small independents outlining

their concerns. They asserted that the rule, because of the increased

costs under index valuation (and associated safety net median value and

transportation allowance requirements), would violate the Regulatory

Flexibility Act. Many claimed that they did not have the staff to

implement the different options and to track the published index

points. They also cited overall concerns that a more complex rule

coupled low prices and higher transportation costs, particularly in the

Rocky Mountains, would harm them. However, one large independent

expressed its support for index-based valuation.

All independents objected to paying additional royalties under the

safety net median value procedure if MMS is late in publishing the

final safety net median value. Many objected to comparing spot sales

valued on an index price to other types of sales valued on gross

proceeds under the safety net procedure. They also objected to paying

royalties on their entitled share of production under a mixed agreement

because it would discriminate against them as a small producer who

cannot market its full share of production every month.

Both small and large independents supported:

(1) eliminating the allowance forms and dual accounting for Federal

leases,

(2) using a residue gas price or an index price to value gas at the

wellhead, and

(3) the new definitions of gathering and compression. In addition,

the larger independents recommended:

(1) reordering the benchmarks for valuing mixed agreement

production to which the lessee is entitled but does not sell,

(2) including exceptions to entitlements reporting for mixed

agreements and exceptions to takes reporting (as explained in the June

9, 1995, Federal Register, 60 FR 30492, Amendments of Regulations to

Establish Liability for Royalty Due on Federal and Indian Leases, and

To Establish Responsibility to Pay and Report Royalty and Other

Payments) for agreements containing only Federal leases with the same

royalty rate and fund recipients, so-called 100 percent Federal

agreements, and

(3) clarifying that royalties must be reported and paid on a

lessee's takes for 100 percent Federal agreements.

The larger independents opposed:

[[Page 25423]]

(1) the provision denying royalty-free use of gas downstream from

the facility measurement point (FMP),

(2) the proposal to require royalties on gas contract settlement

monies received by payors using index-based valuation,

(3) the concept of looking to an affiliate's resale under the

benchmarks, and

(4) the exclusion of coalbed methane for consideration as a

separate zone (as defined in the November 6, 1995, Federal Register

Notice) under index-based valuation.

Majors (9 Commenters)

The majors held the same views as the independents on many issues:

--Allowance forms,

--Dual accounting,

--Wellhead valuation option,

--Takes for 100 percent Federal agreements with exceptions,

--The mixed agreement benchmarks,

--Royalty-free use of gas downstream of the FMP,

--Royalties on gas contract settlement monies,

--Late publication of the final safety net median value,

--Looking to an affiliate's resale price, and

--Coalbed methane.

However, the majors diverged from independents regarding

entitlements reporting for mixed agreements and index-based valuation.

In keeping with the consensus of the Committee, the majors advocated

entitlements for mixed agreements and index-based valuation as an

alternative to gross proceeds.

One major requested that the rule be more explicit that MMS is

accepting a ``range'' of values for royalty purposes and that the

highest one isn't necessarily what determines value. They also wanted

assurance that gross proceeds values would not be subject to additional

royalties by comparison to indices. They opposed any additional

royalties if MMS delays publishing the final safety net median value.

Trade Associations (6 Commenters)

The various trade associations represented primarily majors,

independents, or both groups. Therefore, their comments were mixed on

several issues. Only two trade associations, representing independents,

provided negative views towards index-based valuation. Understandably,

their comments were very similar to the independents' comments.

In general, the trade associations held the same views as the other

industry groups regarding:

--Allowance forms,

--Dual accounting,

--Wellhead valuation option,

--Takes for 100 percent Federal agreements with exceptions,

--Mixed agreement benchmarks,

--Royalty-free use of gas downstream of the FMP,

--Royalties on gas contract settlement monies,

--Late publication of the final safety net median value,

--Looking to an affiliate's resale price, and

--Coalbed methane.

They also recommended:

(1) allowing all compression after the separator as a cost of

transportation,

(2) retaining the term ``location differential'' as adopted by the

Committee (in the March 1995 Final Report of the Committee) in

situations where the lessee's gas does not flow to the Index Pricing

Point (as defined in the November 6, 1995, Federal Register Notice)

used for valuation, and

(3) allowing full depreciation on all newly purchased

transportation or processing facilities, regardless whether previously

depreciated under an MMS schedule.

Most all independent, major, and trade association commenters

agreed that all reporting issues should be left to the Royalty Policy

Committee's Subcommittee on Royalty Reporting and Production

Accounting.

States (3 Commenters)

The States' basically objected to the option to allow index-based

valuation. A few could live with it if the safety net median value

procedure remained intact. However, they objected to the limits imposed

on additional royalties and the abundance of options for valuation.

Therefore, they insisted on retaining an election period minimum of 2

years for all options to prevent manipulation of royalty valuation.

They also pointed out perceived inequities between lessees paying on

gross proceeds and those paying on an index price:

(1) The election procedure discriminates against dedicated (as

defined in the November 6, 1995, Federal Register Notice) contract

holders who have no options but to pay on gross proceeds.

(2) Lessees paying on gross proceeds are treated inequitably if

lessees paying on an index price are allowed to pay on less than market

value.

(3) Lessees paying on gross proceeds have less transportation

allowance options.

(4) Lessees paying on an index price are excused from the

``marketable condition'' requirement applicable to gross proceeds.

The States also believed there should be no limit on additional

royalties under the safety net median value procedure because:

(1) the median value calculation protects the lessee from high-

priced contracts,

(2) the limits were only agreed to prior to developing the

abundance of options, and

(3) lessees should pay on the full market value of production, not

a percentage.

The States were concerned that index prices or residue gas prices

applied to the wellhead would cost them revenues because of the forgone

loss of the value of liquids extracted from the gas.

Further, the States believed that there should be no interest

holiday for the period prior to the initial safety net median value

calculation (that is, interest should accrue from the date of

production). They stressed that accurate reporting is critical to the

safety net median value procedure. They were concerned that the new

gathering definition would lead to a loss in royalty revenue, and

suggested using the FMP as the dividing line between gathering and

transportation. The States supported or recommended:

(1) entitlements for mixed agreements, with no exception to pay on

takes for small producers. One State opposed waiving interest for

lessees paying on takes for the period prior to the deadline to pay on

entitlements.

(2) royalties due on gas contract settlement monies,

(3) new benchmarks providing for great latitude in establishing

value, including looking to an affiliate's resale price and prices

reported to public utility commissions or the Federal Energy Regulatory

Commission,

(4) excluding quality as a factor in determining zones (such as for

coalbed methane), and

(5) developing zones only within or close to areas with valid index

prices.

III. Options for Proceeding

Because the comments on the proposed rule were substantial,

particularly from independents and the States, we are considering five

options for proceeding with a final rulemaking on the valuation of gas

from Federal leases. We request comments from all interested parties on

each of the following five options.

Option 1

--Publish a final rule implementing the consensus of the Committee with

minor modifications reflecting the comments received from the public.

[[Page 25424]]

1. Write the final rule in plain English.

2. Adopt the minor procedural and technical improvements suggested

in the public comments that would not modify the consensus of the

Committee.

3. Delete the second sentence in proposed 30 CFR 202.450(b),

denying royalty-free use of gas downstream of the FMP.

4. Include a provision for takes-based reporting for 100 percent

Federal agreements and stand alone leases.

Issues for Which MMS Specifically Requested Comments in the Proposed

Rule

5. If the final safety net median value is not published within 2

years following the end of the applicable calendar year, then we would

not require the lessee paying on an index-based method to pay interest

from the end of the 2 years until we publish the final safety net

median value. If we have still not published the final safety net

median value within 2 years and 6 months after the end of the calendar

year, then the initial safety net median value becomes the final safety

net median value.

6. We would require index-based payors to pay royalty on contract

settlement proceeds received from settlement entered into after the

effective date of the rule.

7. For overtaken volumes in a mixed agreement by a small producer

who paid on takes, we would process the credit through a recoupment

based on the weighted average value of the previous year's sales.

8. We would issue separate guidance on the reporting of gas

valuation methods consistent with the recommendations of the Royalty

Policy Committee's Subcommittee on Royalty Reporting and Production

Accounting.

9. We would publish a separate rulemaking on benchmark valuation

taking into consideration the comments received under the November 6,

1995, proposed rule.

Option 2

--Retain the Committee's index-based method but replace the MMS-

calculated safety net median value with a safety net value based on

company specific data.

For example, at the end of the applicable calendar year we would

require an index-based payor to compare the weighted average of its

index-based values for its production in the zone to its own weighted

average pool price (net of transportation) for all of its arm's-length

sales of production from the zone. This would include all arm's-length

sales in the pool including sales by an affiliate. If the weighted

average index-based value is within plus or minus a certain percent of

the weighted average pool price, then there is no additional royalty or

no refund. However, if the weighted average index-based value for the

zone for the year is a certain percent (or more) greater than the

weighted average pool price net at the lease, we would issue a refund

to the index-based payor. Likewise, if the weighted average index-based

value for the year is a certain percent (or more) less than the

weighted average pool price, then the index-based payor would owe

additional royalty. This provision would be self-implementing and

subject to audit.

Option 3

--Retain the basic philosophy of the Committee's index-based method but

propose changes to simplify the rule as follows:

1. Index-based valuation must be applied to the wellhead MMBtu. No

option to value residue gas based on an index price and no option for

gross proceeds payors to apply a gross-proceeds based residue value to

the wellhead MMBtu.

2. Retain the safety net median value procedure, but eliminate the

additional royalty limitations.

3. Determine the Index Pricing Point using the weighted average

method. No option to use the fixed-index method (both of these methods

are described in the November 6, 1995, Federal Register Notice).

4. The safety net median value would be based on the weighted

average of all arm's-length gross proceeds in the zone.

5. For all arm's-length transportation and all jurisdictional (as

defined in the November 6, 1995, Federal Register Notice)

transportation, the transportation allowance would equal the weighted

average of all of the actual rates paid to each of the applicable Index

Pricing Points through which the lessee's gas flowed. For non-arm's-

length, non-jurisdictional transportation, lessees would use third

party arm's-length transportation contracts as recommended by the

Committee.

6. In order to provide more certainty and consistency, modify the

``bright line'' (distinction) between transportation and gathering to

be at the FMP consistent with the ``bright line'' test for the

allowability of compression. We would approve exceptions on a case-by-

case basis. Add a provision to prevent manipulation in location of

compressors.

Option 4

--Retain the Committee's index-based method but propose changes to

simplify the rule as follows:

1. Eliminate the MMS-calculated safety net median value and instead

use the self-implementing company-based safety net value described in

option 2 above.

2. The index-based value must be applied to the wellhead MMBtu. No

option to value residue gas based on an index price. Gross proceeds

payors would have the option to apply a gross-proceeds based residue

value to the wellhead MMBtu with a self-implementing safety net value

procedure that compares the gross proceeds of their processed gas and

NGL's with the gross proceeds residue gas price applied to the wellhead

MMBtu. Provisions for refund/payment would be the same as under option

2 above.

3. Determine the Index Pricing Point using the closest index

pricing point to which the gas physically flows using any valid

publication (as described in the November 6, 1995, Federal Register

Notice).

4. For all arm's-length transportation and all jurisdictional

transportation, the transportation allowance would equal the actual

rate paid to the closest index pricing point. For non-arm's-length,

non-jurisdictional transportation, use third-party arm's-length

transportation contracts as recommended by the Committee.

5. In order to provide more certainty and consistency, modify the

``bright line'' (distinction) between transportation and gathering to

be at the FMP consistent with the ``bright line'' test for the

allowableness of compression. Exceptions may be approved by us on a

case-by-case basis. Add a provision to prevent manipulation in location

of compressors.

Option 5

--Do not implement the alternative valuation options recommended by the

Committee and instead:

1. Maintain the current gross proceeds-based valuation regulations

with modifications to simplify the current benchmark system for non-

arm's-length sales at 30 CFR 206.152(c) and 206.153(c) (1995) as

follows: First Benchmark: Weighted average of comparable arm's-length

contracts in the field or area between third parties and the lessee or

its affiliate. Comparable arm's-length contracts are those whose

volumes are within plus or minus 20 percent of the volumes sold

[[Page 25425]]

under the non-arm's-length contract on a monthly basis. MMS requests

comments on whether the volume transferred under a non-arm's-length

arrangement should be evaluated on the basis of all gas under the

contract or by the size of each individual delivery package. Second

Benchmark: First bona-fide arm's-length sale by the affiliate, except

to retail customers. Third Benchmark: Other relevant matters.

2. Adopt the Committee's recommendation for entitlements-based

reporting for mixed agreements, but with no exception for small

producers. Under limited circumstances, allow MMS-approved exceptions

to entitlements-based reporting if all lessees agree.

3. Adopt industry's comments to include in this rule the explicit

provision for takes-based reporting for 100 percent Federal agreements

and stand alone leases.

4. In response to the State's comments and in order to provide more

certainty and consistency, modify the ``bright line'' (distinction)

between transportation and gathering to be at the FMP, consistent with

the ``bright line'' test for the allowability of compression. We may

approve exceptions on a case-by-case basis. Add a provision to prevent

manipulation in the location of compressors.

IV. Request for Public Comments

It is our intent to publish regulations that are: (1) Clear and

understandable (2) responsive to the changing needs of royalty payors,

(3) equitable to all affected parties, and (3) practical for us to

administer. Such regulations should reduce administrative costs to both

payors and MMS, while not generating a significant loss of royalty

revenues. Based on the comments received, we are concerned that the

proposed rule may not satisfy these goals. Therefore, we request input

on how to improve the gas valuation regulations so that all affected

parties benefit.

We specifically request comments on the five options outlined above

for finalizing the proposed regulations in light of the public comments

we received. We recognize that, for each affected party, each option

holds benefits in certain areas while containing drawbacks in other

areas. We emphasize that the five listed options are not exhaustive but

merely suggestions for an improved, simplified, and streamlined

valuation process. We welcome any new options or any modifications to

the proposed options for consideration.

We are not requesting comments on the summary of comments outlined

in this notice, only on the five options described above or other

options suggested for valuing gas from Federal leases.

The policy of the Department is, whenever practicable, to give the

public an opportunity to participate in the rulemaking process.

Accordingly, you should submit written comments, suggestions, or

objections regarding this notice to the location identified in the

ADDRESSES section of this notice. You should submit comments on or

before the date identified in the DATES section of this notice.

Dated: May 15, 1996.

Michael A. Miller,

Acting Associate Director for Royalty Management.

[FR Doc. 96-12723 Filed 5-20-96; 8:45 am]

BILLING CODE 4310-MR-P