[Federal Register Volume 63, Number 136 (Thursday, July 16, 1998)]
[Proposed Rules]
[Pages 38355-38357]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-19135]


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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

[[Page 38356]]

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

[[Page 38357]]

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