Establishing Oil Value for Royalty Due on Federal Leases

DEPARTMENT OF THE INTERIOR

Minerals Management Service

30 CFR Part 206

RIN 1010-AC09

Establishing Oil Value for Royalty Due on Federal Leases

AGENCY: Minerals Management Service, Interior.

ACTION: Further supplementary proposed rule.

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SUMMARY: The Minerals Management Service (MMS) is proposing additional

changes to its second supplementary proposed rulemaking regarding the

valuation of crude oil produced from Federal leases.

DATES: Comments must be submitted on or before July 24, 1998.

ADDRESSES: Mail comments, suggestions, or objections regarding the

proposed rule to: Minerals Management Service, Royalty Management

Program, Rules and Publications Staff, P.O. Box 25165, MS 3021, Denver,

Colorado 80225-0165, e-mail address is RMP.[email protected].

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

Publications Staff, Royalty Management Program, Minerals Management

Service, telephone (303) 231-3432, fax (303) 231-3385, e-mail

RMP.[email protected].

SUPPLEMENTARY INFORMATION:

I. Background

MMS published an advance notice of its intent to amend the current

Federal oil valuation regulations in 30 CFR parts 202 and 206 on

December 20, 1995 (60 FR 65610). The purpose of this notice was to

solicit comments on new methodologies to establish the royalty value of

Federal (and Indian) crude oil production in view of the changes in the

domestic petroleum market and particularly the market's move away from

posted prices as an indicator of market value.

Based on comments received on the advance notice, together with

information gained from a number of presentations by experts in the oil

marketing business, MMS published its initial notice of proposed

rulemaking on January 24, 1997 (62 FR 3742), applicable to Federal

leases only. MMS held public meetings in Lakewood, Colorado, and

Houston, Texas, to hear comments on the proposal.

In response to the variety of comments received on the initial

proposal, MMS published a supplementary proposed rule on July 3, 1997

(62 FR 36030). This proposal expanded the eligibility requirements for

valuing oil disposed of under arm's-length transactions.

Because of the substantial comments received on both proposals, MMS

reopened the rulemaking to public comment on September 22, 1997 (62 FR

49460). MMS specifically requested comments on five valuation

alternatives arising from the public comments. MMS held seven public

workshops to discuss valuation alternatives.

As a result of comments received on the proposed alternatives and

comments made at the public workshops, MMS published a second

supplementary proposed rule on February 6, 1998 (63 FR 6113). The

comment period for this second supplementary proposed rule was to close

on March 23, 1998, but was extended to April 7, 1998 (63 FR 14057). MMS

held five public workshops (63 FR 6887) on this second supplementary

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proposed rule: in Houston, Texas, on February 18, 1998; Washington,

D.C., on February 25, 1998; Lakewood, Colorado, on March 2, 1998;

Bakersfield, California, on March 11, 1998; and Casper, Wyoming, on

March 12, 1998.

By Federal Register notice dated July 8, 1998, (63 FR 36868) MMS

reopened the comment period for the February 6, 1998, second

supplementary proposed rule from July 9, 1998, until July 24, 1998, to

receive further comment on the proposed rule. A meeting involving MMS,

several industry representatives, and members of Congress was held in

Washington, D.C., on July 9, 1998.

II. Revisions to Supplementary Proposed Rule

In response to comments received so far, MMS is proposing some

changes to the February 6, 1998, second supplementary proposed rule.

MMS is requesting public comments on these further proposed provisions.

Definition of ``Affiliate''

Several commenters to the February 6, 1998, second supplementary

proposed rule objected to the proposed definition of ``affiliate'' in

Sec. 206.101. Under this proposed definition, 10 percent ownership was

the threshold for defining control, requiring non-arm's-length

valuation for transactions between persons with such a degree of

affiliation. Commenters argued that 10 percent was too low because

affiliates with this small amount of ownership actually have no control

over the affiliated entity. Accordingly, they believed that too many

lessees would be excluded from using their gross proceeds as value in

bona fide arm's-length transactions. They suggested retaining the

current definition of affiliate, as defined by the term ``arm's-length

contract,'' where ownership of 10 percent through 50 percent creates a

presumption of control. One commenter suggested 20 percent to 50

percent ownership as the criteria for creating a presumption of

control, consistent with the definition used by the Bureau of Land

Management. One commenter suggested deleting reference to partnerships

and joint ventures because lessees might not have access to records of

these entities and these terms could create confusion as to whether the

affiliate test applies to the property, field, or corporate level.

MMS understands the concern raised in the industry comments

regarding presumption of control. Therefore, MMS now is proposing to

retain the current meaning of affiliate embodied in the current rules

at proposed Sec. 206.101. Less than 10 percent ownership would create a

presumption of non-control. Ownership of between 10 and 50 percent

would create a presumption of control that the lessee could rebut.

Ownership in excess of 50 percent would establish control.

However, in the current rule, affiliation is defined within the

definition of the term ``arm's length.'' In this proposed rule,

although we have retained the current meaning of affiliation, we have

made ``affiliate'' a separate definition from ``arm's length.'' We

believe this clarifies and simplifies the definitions and should

promote better understanding of both ``arm's length'' and

``affiliate.''

Breach of Duty to Market

Some commenters were concerned about the provision in proposed

Sec. 206.102(c)(2)(ii) which allows MMS to disallow arm's-length gross

proceeds as royalty value if the lessee breaches its duty to market its

oil for the mutual benefit of the lessee and lessor. The concern

expressed was that MMS would use this provision to ``second-guess'' a

lessee's marketing decision and thereby force the lessee to use index-

based valuation.

The provision which is the subject of the commenters' concerns is

identical to the provision in the existing rules (see 30 CFR

Sec. 206.102(b)(1)(iii)) and has been in the rules for more than 10

years. This provision has never been used to ``second-guess'' a

lessee's marketing decisions to try to impose benchmarks of

Sec. 206.102(c) on arm's-length transactions. Nevertheless, MMS is also

proposing to modify the proposed Sec. 206.102(c)(2) to clarify that the

lessee's duty to market does not mean that MMS will second-guess a

company's marketing decisions. Lessees generally may structure their

business arrangements however they wish, and absent misconduct, MMS

will look to the ultimate arm's-length disposition in the open market

as the best measure of value. The provision's purpose is to protect

royalty value if, for example, a lessee were to inappropriately enter

into a substantially below-market transaction for the purpose of

reducing royalty.

Exchanges

The July 3, 1997, supplementary proposed rule extended the use of

gross proceeds valuation to oil exchanged and then sold at arm's

length. In those cases where a lessee disposed of the produced oil

under an exchange agreement with a non-affiliated person, and after the

exchange the lessee sold at arm's length the oil acquired in the

exchange, the lessee would have had the option of using either its

gross proceeds under the arm's-length sale or the index pricing method

to value the lease production (proposed paragraph 206.102(a)(6)(i)).

This option would have applied only when there was a single exchange.

If the lessee chose gross proceeds under this option, the lessee would

have valued all oil production disposed of under all other arm's-length

exchange agreements in the same manner (proposed paragraph

206.102(a)(6)(iii)). For any oil exchanged or transferred to

affiliates, or subject to multiple exchanges, the lessee would have

used the index pricing method to value the lease production (proposed

paragraph 206.102(a)(6)(ii)).

Participants in MMS's workshops held in October 1997 indicated that

they often use several exchanges to transport their production from

offshore leases to onshore market centers. They believed that MMS

should give the lessee an option of valuing exchanged oil either by

using so-called ``lease-market'' benchmarks (rather than index prices)

or by using the lessee's resale price less an exchange differential,

regardless of the number of exchanges needed to reposition the crude

oil for sale.

In response to those comments, in the February 6, 1998, proposal,

MMS expanded gross proceeds valuation to include situations where the

oil received in exchange is ultimately sold arm's-length, regardless of

the number of arm's-length exchanges involved. However, because of the

numerous industry and State comments now claiming that tracing multiple

exchanges would be overly burdensome, if not impossible, MMS is

proposing to return to the July 3, 1997, proposal's ``first-exchange''

rule, where value will be determined based on the arm's-length sale

after a single arm's-length exchange. MMS is proposing to modify

Sec. 206.102 (c)(3) so that if two or more exchanges are involved, even

if they are all at arm's length, the lessee must use index pricing.

Gathering vs. Transportation

MMS received comments on the definition of ``gathering'' as

contained in the existing regulations in 30 CFR 206.101, which is the

same as in proposed Sec. 206.101. The commenters noted that

development, especially of deepwater leases, often involves a sub-sea

completion with no platform. Bulk, unseparated production is moved

sometimes in excess of 50 miles to a platform where it first surfaces

and is treated. The commenters asserted that in these situations the

movement of production from sub-sea production over long distances

should be deductible as a transportation allowance. MMS specifically

requests

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comment on whether the definition of gathering should be modified to

address this situation.

MMS requests comments on the revisions to the second supplementary

proposed rule (63 FR 6113) including this notice or any other comments

you may want to submit on this proposed rule. If you have commented

already on other portions of the rule, you do not need to resubmit

those comments since they are already part of the rulemaking record.

MMS will respond to comments in the final rule.

List of Subjects in 30 CFR Part 206

Coal, Continental Shelf, Geothermal energy, Government contracts,

Indians--lands, Mineral royalties, Natural gas, Petroleum, Public

lands--mineral resources, Reporting and recordkeeping requirements.

Dated: July 14, 1998.

Sylvia V. Baca,

Acting Assistant Secretary, Land and Minerals Management.

For the reasons set forth in the preamble, the second supplementary

proposed rule published at 63 FR 6113 on February 6, 1998, amending 30

CFR Part 206, is further amended as follows:

PART 206--PRODUCT VALUATION

1. The Authority citation for Part 206 continues to read as

follows:

Authority: 5 U.S.C. 301 et seq.; 25 U.S.C. 396 et seq., 396a et

seq., 2101 et seq.; 30 U.S.C. 181 et seq., 351 et seq. 1001 et seq.

1701 et seq.; 31 U.S.C. 9701, 43 U.S.C. 1301 et seq. 1331 et seq.,

and 1801 et seq.

Subpart C--Federal Oil

2. Section 206.101 as proposed to be revised at 63 FR 6113 is

further amended by revising the following definition to read as

follows:

Sec. 206.101 Definitions

Affiliate means a person who controls, is controlled by, or is

under common control with another person.

(1) For this subpart, based on ownership of an entity's voting

securities, interest in a partnership or joint venture, or other forms

of ownership:

(i) Ownership greater than 50 percent constitutes control;

(ii) Ownership of 10 through 50 percent creates a presumption of

control; and

(iii) Ownership of less than 10 percent creates a presumption of

noncontrol that MMS may rebut if it demonstrates actual or legal

control, including but not limited to interlocking directorates.

(2) MMS may require the lessee to certify the percentage of

ownership. Aside from the percentage ownership criteria, relatives,

either by blood or marriage, are affiliates.

3. Section 206.102 as proposed to be revised at 63 FR 6113 is

further amended by revising paragraphs (c)(2) and (c)(3) to read as

follows:

Sec. 206.102 How do I calculate royalty value for oil that I or my

affiliate sell under an arm's-length contract?

* * * * *

(c) * * *

(2) You must value the oil under Sec. 206.103 if MMS determines

that the value under paragraph (a) of this section does not reflect the

reasonable value of the production due to either:

(i) Misconduct by or between the parties to the arm's-length

contract; or

(ii) Breach of your duty to market the oil for the mutual benefit

of yourself and the lessor. MMS will not use this provision to dispute

lessees' marketing decisions made reasonably and in good faith. It will

apply only when a lessee or its affiliate inappropriately sells its oil

at a price substantially below market value.

(3) You must use Sec. 206.103 to value oil disposed of under an

exchange agreement. However, if you enter into a single arm's-length

exchange agreement, and following that exchange you dispose of the oil

received in the exchange in a transaction to which paragraph (a) of

this section applies, then you must value the oil under paragraph (a)

of this section. Adjust that value for any location or quality

differential or other adjustments you received or paid under the arm's-

length exchange agreement(s). But if MMS determines that any arm's-

length exchange agreement does not reflect reasonable location or

quality differentials, MMS may require you to value the oil under

Sec. 206.103. If you enter into more than one sequential exchange

agreement to dispose of your production, you must use Sec. 206.103 to

value that production.

* * * * *

[FR Doc. 98-19135 Filed 7-15-98; 8:45 am]

BILLING CODE 4310-MR-P