[Federal Register Volume 61, Number 99 (Tuesday, May 21, 1996)]
[Proposed Rules]
[Pages 25421-25425]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12723]



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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