Royalty Computation on Phosphate Production on Western Public Lands

DEPARTMENT OF THE INTERIOR

Minerals Management Service

Royalty Computation on Phosphate Production on Western Public

Lands

AGENCY: Minerals Management Service, Interior.

ACTION: Notice of proposed revision of method for determining value

used to compute royalty payments on phosphate ore mined on western

public lands.

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SUMMARY: The Minerals Management Service (MMS) is soliciting comments

on a proposal to adopt a new method for determining the value of

production used to compute royalties on phosphate ore produced from

Federal leases in the State of Idaho.

DATES: Submit comments on or before April 23, 1998.

ADDRESSES: Send your written comments to David S. Guzy, Chief, Rules

and Publications Staff, Royalty Management Program, Minerals Management

Service, PO Box 25165, MS 3021, Denver, Colorado 80225-0165; or e-Mail

RMP.[email protected].

FOR FURTHER INFORMATION CONTACT: Herbert B. Wincentsen, Chief, Solid

Minerals Valuation and Reporting Branch, Minerals Management Service,

PO Box 25165, Mail Stop 3153, Denver, Colorado 80225-0165, telephone

(303) 275-7210.

SUPPLEMENTARY INFORMATION: On October 16, 1997, the Secretary of the

Interior (Secretary) approved an April 16, 1997, recommendation from

the Royalty Policy Committee (RPC) to revise the current method of

adjusting the value used to compute royalty payments on Federal

phosphate production.

RPC is a committee of the MMS Advisory Board (Board). The Board was

created under the authority of the Federal Advisory Committee Act. The

Board's purpose includes, in relevant part, providing advice to the

Secretary, the Director, MMS, and other Department of the Interior

(Department) officials on royalty management of Federal and Indian

leases. RPC includes representatives of States which share in mineral

revenues from Federal lands; Indian tribes and allottees whose mineral

revenues MMS collects in trust; and oil and gas and solid minerals

producing industries who pay royalties; and the public.

RPC Recommendations

RPC made the following recommendations concerning phosphate

valuation which were approved by the Secretary:

1. The current indexing procedure, which utilizes the Gross

Domestic Product--Implicit Price Deflator (GDP-IPD) to annually adjust

the phosphate value for royalty calculation purposes, should be

discontinued.

2. The phosphate value should be determined using a weighted

composite index methodology having the following indices and weights:

The Chemical and Fertilizer Minerals Mining Index

(Standard Industry Code (SIC) 147), weighted at 50 percent.

The Phosphate Rock Index (SIC 1475), weighted at 25

percent.

The Phosphatic Fertilizers Index (SIC 2874), weighted at

25 percent.

The phosphate unit value would be recalculated annually, as under

the existing indexing procedure.

3. This recommended methodology should continue for 5 years, at

which time the methodology and the values determined thereunder will be

examined to assure there is a continued relationship to the

marketplace.

4. The valuation methodology applies only to Federal phosphate

production; there is no Indian phosphate production. State or fee

phosphate leases are also unaffected unless the parties to a State or

fee lease elect to use the Federal valuation methodology.

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5. The recommended composite indexing method will not be

retroactive. The methodology will become effective if and when approved

by the Department.

Problems Identified in RPC Report

RPC identified the following problems with the current phosphate

valuation method:

1. There is a lack of open market (arm's-length) sales of phosphate

ore, the product on which the value for royalty purposes is based. The

Western phosphate industry has been, and continues to be, characterized

by vertically integrated companies. These companies consume virtually

all phosphate ore production internally, to make a variety of

downstream refined phosphate based fertilizers and elemental

phosphorus.

2. About 16 years have elapsed since the Department adopted an

indexed valuation adjustment method using GDP-IPD. As expected, the

P205 unit value has steadily increased each year,

consistent with the use of a broad-based measure of price changes such

as the GDP-IPD.

3. Comparison of the Federal GDP-IPD indexed-valuation methodology

to the market shows that its use has failed to accurately track the

relative rise and fall of a single product or market such as that for

phosphate rock; therefore, a valuation problem currently exists.

4. The valuation problem will grow with continued use of the GDP-

IPD. The continued use of the GDP-IPD will increase the

P205 unit value at the same rate as the IPD

deflates the GDP. This is not a true reflection of changes in the

phosphate marketplace because it does not take into consideration the

changing phosphate product consumption pattern and the ancillary price

impacts on phosphate ore.

Background of Phosphate Ore Valuation

Valuation Before 1975

Before 1975, phosphate royalty payments were based on a lease-

imposed minimum rate of $0.25 per ton. Federal phosphate leases have

historically carried lease terms requiring royalty to be paid on the

greater of either $0.25 per ton or 5 percent of the gross value. Under

this term, the 5 percent rate applies whenever the gross value exceeds

$5 per ton. Before 1975, the value was assumed to be less than $5 per

ton and thus the royalty rate remained fixed at $0.25 per ton.

Valuation From 1975 to 1981

In the early 1970's phosphate rock prices rapidly increased,

surpassing the $5 per ton benchmark price for application of the 5-

percent royalty rate. In 1974, an audit by the Department (the Office

of Audit and Investigation) concluded that the Federal Government was

not following its statutory mandate to collect not less than 5 percent

of the gross value.

However, required use of the ad valorem royalty rate introduced a

new problem. The Western phosphate industry is, for the most part, a

vertically integrated industry internally consuming phosphate lease ore

production in either electric furnaces to make elemental phosphorus or

in wet acid plants to make a variety of phosphate-based fertilizers.

The absence of significant quantities of open market sales was

problematic since the ad valorem royalty was based on the unit sale or

contract price obtained under bona fide arm's-length sales, as

specified by regulations at 30 CFR 206.301 (1997).

Following extensive analysis over several years, then Secretary

Thomas S. Kleppe decided on May 13, 1976, to use a net back valuation

methodology where in open market (arm's-length) sales of beneficiated

phosphate rock would be adjusted for beneficiation and related costs to

arrive at the gross value of mine output, which is phosphate ore. This

``Kleppe Method'' valuation procedure was made retroactive to January

1, 1975.

The Kleppe Method was difficult to administer. In an advance notice

published in the Federal Register (45 FR 74065, November 7, 1980), the

Department stated that there were two problems related to the continued

use of the Kleppe formula:

During the period 1975 through 1979, arm's-length sales, both

long-term sales and spot sales, were of sufficient magnitude to

establish a realistic product value. In 1980, however, arm's-length

sales diminished to less than 1 percent of total mine production in

the western phosphate region...

Also, this method was cumbersome, as it required the phosphate

lessees to submit all their cost and sales data. These data, in

turn, were audited by the Department and, after several months, a

gross value was established. In most years, the royalty assessment

was not determined until after the mining year was completed.

To overcome these problems, the Department recommended adoption of

an index adjustment methodology; however, no specific index was

recommended. The Department also solicited proposals on other methods

for valuing phosphate ore.

Valuation From 1981 to the Present

Effective January 1, 1981, the Department adopted the index-based

adjustment for P205 unit value determination in a Federal Register

release (46 FR 9210, January 28, 1981). The index selected was the GDP-

IPD, as published by the U.S. Department of Commerce, Bureau of

Economic Analysis. In selecting that index, the Department left open

the question of future valuation procedures, stating:

If a better method is developed that more accurately reflects

the value of phosphate rock, it will be considered at that time.

MMS has routinely recalculated each year's value and provided that

value to industry. By 1995, MMS recognized that the GDP-IPD adjustment

mechanism was developing values that did not appear to correlate with

phosphate market changes. Moreover, if allowed to continue, the GDP-IPD

adjusted phosphate value would eventually become completely unrelated

to the marketplace. Operating under the RPC, the Phosphate Study Group

and later, the Phosphate Valuation Subcommittee, was formed to examine

whether an alternative valuation methodology could be agreed upon to

replace the GDP-IPD index.

Chronology of Meetings

In March 1995, MMS contacted the State of Idaho, industry, and the

Bureau of Land Management (BLM) asking for expressions of interest to

form a study group to examine the Federal phosphate royalty valuation

issue. All parties contacted agreed to meet to discuss the Federal

phosphate valuation issue and, on June 22, 1995, these parties met with

MMS representatives at BLM's Pocatello office. MMS representatives

briefed the parties on (1) the phosphate valuation issue, (2) the

Federal Advisory Committee Act, and (3) the relationships of the RPC

and the various subcommittees.

In 1995, when RPC was initially formed, a subcommittee named the

Phosphate and Other Leasable Solid Minerals Subcommittee was formed.

This subcommittee was intended not only to address the phosphate

valuation issue but perhaps other, not yet specified issues for other

solid minerals. However, no additional meetings of this subcommittee

occurred subsequent to its formation.

In a letter dated February 2, 1996, the RPC Chair notified the

Chair of the Phosphate and Other Leasable Solid Minerals Subcommittee

of his decision to segregate the phosphate valuation issue. In doing

so, the Phosphate Subcommittee was created.

The Phosphate Subcommittee initially met on April 25, 1996, at J.R.

Simplot's office in Pocatello, Idaho. Rules for

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conducting the meeting and for approving recommendations were

established. The composition of the Phosphate Subcommittee was

modified, with the Caribou County Treasurer substituting for the

representative from the Idaho State Treasurer's office. The final

composition of the Phosphate Subcommittee included industry

representatives, the Caribou County Treasurer, a representative from

the Idaho State Lands, and a member of the public. MMS facilitators and

BLM representatives also attended the meetings, providing background

material, detailed analysis of the issue, and guiding the discussion.

The Phosphate Subcommittee agreed to address the following issues:

1. Has the phosphate market changed in the last 15 years? If so,

how has it impacted valuation?

2. Is the index adjustments using the GDP-IPD accurate or is there

a more accurate method of valuing phosphate ore that should replace the

GDP-IPD adjustment method?

3. Is the value accurate or should it be adjusted?

The Phosphate Subcommittee agreed not to reconvene until a proposal

had been made. In the interim, MMS representatives and Idaho BLM

representatives met on July 23 and 24, 1996, with a Washington Office

BLM official for briefing on the purpose of the Phosphate Subcommittee.

The Phosphate Subcommittee reconvened on November 19, 1996, at

BLM's Pocatello office to discuss an October 31 proposal to use a

weighted-average composite index to adjust the annual unit value for

phosphate valuation. The members agreed to review the proposal and

reconvene in January 1997.

The Phosphate Subcommittee reconvened on January 22, 1997, at BLM's

Pocatello office. Industry concurred with the proposal. The State and

County officials, while agreeing that a valuation problem existed under

the present methodology, were unable to recommend adoption of an

alternative methodology that might impact royalty revenue streams that

benefit the school system and county infrastructure.

The nonconsensus recommendation was presented to the RPC for

consideration on April 16, 1997. RPC approved the recommendation under

its voting rules, with 9 votes in favor, 1 opposed, and 4 abstentions.

Later, in a letter dated June 4, 1997, the Idaho State Treasurer

wrote to the Chair, RPC, endorsing the RPC recommendation and asking

that the Secretary accept and implement the recommendation.

On October 16, 1997, the Secretary approved the RPC recommendation

for revising the methodology used to compute the value used for Federal

phosphate production royalty payments.

Principal Provisions of the Proposed Valuation Revision

The following constitute the principal provisions of the proposed

valuation revisions:

1. Use Producer Price Indexes (PPI) because PPI:

Measures average changes in selling prices received by

domestic producers (import prices are excluded);

Emphasizes the reporting of realistic transaction prices,

including discounts, premiums, rebates, allowances, etc., rather than

list or book prices. No ``futures markets'' are used; and

Reflects ``point of production'' prices exclusive of

transportation.

2. No single index best represents the western phosphate industry.

However, a composite of PPI's that are closely related to the phosphate

mining industry provide a measurement that is better than the existing

GDP-IPD index:

The Phosphatic Fertilizers Index emphasizes price

movements of downstream phosphate-based fertilizers that were

manufactured from phosphate rock. All phosphate producers do not make

fertilizers. Some are elemental phosphorus producers whose downstream

refined products are not used in the fertilizer industry. Therefore,

this index, in itself, does not represent downstream price changes for

all phosphate producers.

The Chemical and Fertilizer Minerals Mining Index

represents the output of basic mining for phosphate, sodium, borates,

and potash. This is the principal index for measuring mining output,

excluding nonfuel and nonmetals. Also, these minerals are produced

extensively in the western United States; therefore, this index is

responsive to changes in western mine production.

The Phosphate Rock Index represents beneficiated rock

prices, nationwide. The nationwide output of phosphate rock is

dominated by Florida's production; therefore, even though this index

would seem to be most closely allied with the western phosphate

producers, it cannot represent the single best indicator of Idaho

production, particularly since almost all of the Idaho phosphate

production is not sold on the open market.

The weighted composite index methodology is shown in Table 1 below:

Table 1.--Composite Index Methodology for Federal Phosphate Valuation

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Phosphatic Fertilizer

Year fertilizer mining Rock price Composite Index unit

index index index index value

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1988........................................... 127.30 99.60 81.30 101.95 $0.5310

1989........................................... 126.00 104.70 88.20 105.90 0.5516

1990........................................... 115.70 106.70 93.80 105.73 0.5507

1991........................................... 117.90 108.50 96.80 107.93 0.5621

1992........................................... 107.60 108.30 103.70 106.98 0.5572

1993........................................... 97.50 104.30 97.40 100.88 0.5254

1994........................................... 118.60 102.10 94.60 104.35 0.5435

1995........................................... 139.10 104.20 98.00 111.38 0.5801

1996........................................... 150.40 108.60 101.80 117.35 0.6112

Weight Factor (percent)........................ 25 50 25 ........... ...........

Base Year 1987................................. 110.90 96.40 83.20 96.73 0.5038

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As under the existing methodology, the unit value of phosphate ore

is determined with reference to the prior year's index value compared

to the base year value. For example:

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Existing Methodology

[GRAPHIC] [TIFF OMITTED] TN24MR98.092

Revised Methodology

[GRAPHIC] [TIFF OMITTED] TN24MR98.093

The revised methodology would not be applied retroactively.

However, the weighted composite index calculated value would be

compared retroactively to the GDP-IPD based value to form a basis for

correcting for actual phosphate market trends. Using this comparison

technique, 1987 forms a new base value year, when the GDP-IPD indexed

value and the composite indexed (market based) value coalesced.

No attempt would be made to apply a one-time Kleppe Formula (net

back) to determine actual industry production costs and revenues for

the same reasons that were acknowledged by the Department in 1980:

There is a continued lack of bona fide open market sales

from which to base overall revenues and prices.

The process takes too long and is cumbersome, entailing

extensive data collection and consuming audit resources.

The phosphate value computed under the revised methodology would be

examined through a market analysis every 5 years, to ensure that the

new valuation methodology is, in fact, reflecting changes in the

western phosphate industry. Since the analysis that was part of the

Phosphate Subcommittee's work occurred in 1996, the values computed for

phosphate ore will be examined and compared to market data in 2001.

Potential Revenue Impact

The revenue impact associated with this proposed revision to the

value adjustment methodology is difficult to predict because the

selected indexes are relatively more volatile than the GDP-IPD and they

will follow market trends. Had this index been adopted for 1996 the

impact would have been an annual reduction in royalty of about

$444,000, or about 10.6 percent. However, royalty revenue is also

impacted by the level of production from Federal leases as well as the

unit value. Thus, royalty could either increase or decrease based

solely on changes to the level of production even without any change to

the valuation methodology.

Dated: March 17, 1998.

Lucy Querques Denett,

Associate Director for Royalty Management.

[FR Doc. 98-7547 Filed 3-23-98; 8:45 am]

BILLING CODE 4310-MR-P