[Federal Register Volume 70, Number 228 (Tuesday, November 29, 2005)]
[Proposed Rules]
[Pages 71421-71425]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-23380]


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DEPARTMENT OF THE INTERIOR

Minerals Management Service

30 CFR Part 205

RIN 1010-AC29


Reporting and Paying Royalties on Federal Leases on Takes or 
Entitlements Basis

AGENCY: Minerals Management Service (MMS), Interior.

ACTION: Advance notice of proposed rulemaking and announcement of 
public meeting.

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SUMMARY: The MMS requests comments and suggestions to assist us in 
proposing regulations regarding so-called ``takes versus entitlements'' 
reporting and payment of royalties when oil and gas production is 
commingled upstream of the point of royalty measurement. See IV, 
Description of Information Requested, for details.

DATES: You must submit your comments by January 30, 2006. A public 
meeting will be held on December 14, 2005.

ADDRESSES: Please use the regulation identifier number (RIN), RIN 1010-
AC29, in all your correspondence. Submit your comments, suggestions, or 
objections regarding the advanced notice of the proposed rulemaking by 
any of the following methods:
    By regular U.S. mail. Minerals Management Service, Minerals Revenue 
Management, P.O. Box 25165, MS 302B2, Denver, Colorado 80225-0165;
    By overnight mail, courier, or hand-delivery. Minerals Management 
Service, Minerals Revenue Management, Building 85, Room A-614, Denver 
Federal Center, West 6th Avenue and Kipling Blvd., Denver, Colorado 
80225; or
    By e-mail. [email protected]. Please submit Internet comments as 
an ASCII file and avoid the use of special characters and any form of 
encryption. Also, please include ``Attn: RIN 1010-AC29'' and your name 
and return

[[Page 71422]]

address in your Internet message. If you do not receive a confirmation 
that we have received your Internet message, call the contact person 
listed below.

FOR FURTHER INFORMATION CONTACT: Sharron L. Gebhardt, Lead Regulatory 
Specialist, Minerals Management Service, Minerals Revenue Management, 
P.O. Box 25165, MS 302B2, Denver, Colorado 80225-0165, telephone (303) 
231-3211, FAX (303) 231-3781, or e-mail [email protected].

SUPPLEMENTARY INFORMATION:

I. Dates Information

    The MMS may not necessarily consider or include in the 
Administrative Record, for any proposed rule, comments that MMS 
receives after the close of the comment period or comments delivered to 
an address other than those listed in the ADDRESSES section of this 
document.

II. Public Meeting Information

    The MMS will hold a public meeting to allow the public an 
opportunity to comment on how MMS should implement the royalty 
reporting and payment provision at section 6(d) of the Federal Oil and 
Gas Royalty Simplification and Fairness Act (RSFA). The meeting will be 
held in Houston, Texas, on the following date at the following 
specified time and location: Wednesday, December 14, 2005, from 9 a.m.-
1 p.m. central time, in the San Antonio Room located on the second 
floor of the Sheraton North Houston Hotel, located at 15700 John F. 
Kennedy Blvd, Houston, Texas 77032. For further information, please 
contact Roman A. Geissel at (303) 231-3226.

III. Public Comment and Meeting Procedures

A. Written Comment Procedures

    We are particularly interested in receiving comments and 
suggestions about the topics identified in IV, Description of 
Information Requested. Your written comments should: (1) Be specific; 
(2) explain the reason for your comments and suggestions; (3) address 
the issues outlined in this notice; and (4) where possible, if you 
refer to the specific provision, section, or paragraph of statutory 
law, case law, or existing regulations, please cite that provision.
    The comments and recommendations that are most useful and have 
greater likelihood of influencing decisions on the content of a 
possible future proposed rule are: (1) Comments and recommendations 
supported by quantitative information or studies; and/or (2) comments 
that include citations to, and analyses of, the applicable laws and 
regulations.

B. Public Meeting Procedures

    At the public meeting, those attending will be able to comment on 
the scope, proposed action, and possible alternatives the MMS should 
consider. The purpose of the meeting is to gather comments and input 
from a variety of stakeholders and the public.
    If you do not wish to speak at the meeting but you have views, 
questions, or concerns with regard to the MMS's implementation of 
section 6(d) of RSFA, Public Law 104-185, Aug. 13, 1996, 110 Stat 1700, 
1713-1714, as corrected by Public Law 104-200, Sept. 22, 1996, codified 
at 30 U.S.C. 1721(k), entitled ``Volume Allocations of Oil and Gas 
Production,'' you may submit written statements at the meeting for 
inclusion in the public record. You may also submit written comments 
and suggestions regardless of whether you attend or speak at the public 
meeting. See the ADDRESSES section of this document for instructions on 
submitting written comments.
    The site for the public meeting is accessible to individuals with 
physical impairments. If you need a special accommodation to 
participate in the meeting (e.g., interpretive service, assistive 
listening device, or materials in alternative format), please notify 
Lonnie Kimball at (281) 987-6800, no later than 2 weeks prior to the 
scheduled meeting. Although we will make every effort to accommodate 
requests received, it may not be possible to satisfy every request.

C. Public Comment Policy

    Our practice is to make comments, including names and home 
addresses of respondents, available for public review at our Denver 
office during regular business hours and on our Web site at http://www.mrm.mms.gov/Law_R_D/FRNotices/FRHome.htm, or on request to 
Sharron Gephardt at (303) 231-3211. Individual respondents may request 
that we withhold their individual home address from the rulemaking 
record, which we will honor to the extent allowable by law. There also 
may be circumstances in which we would withhold from the rulemaking 
record a respondent's identity, as allowable by law. If you wish us to 
withhold your name and/or address, you must state this prominently at 
the beginning of your comments. However, we will not consider anonymous 
comments. We will make all submissions from organizations or 
businesses, and from individuals identifying themselves as 
representatives or officials of organizations or businesses, available 
for public inspection in their entirety.

IV. Description of Information Requested

    On August 13, 1996, the President signed RSFA into law. Section 
6(d) of RSFA, entitled, ``Volume Allocations of Oil and Gas 
Production,'' amended section 111 of the Federal Oil and Gas Royalty 
Management Act of 1982 (FOGRMA), Public Law 97-451--Jan. 12, 1983 (30 
U.S.C. 1721), by adding new paragraphs (k)(1)-(5). The proposed 
rulemaking would implement RSFA amendments to FOGRMA section 111(k)(1)-
(4).
    Congress enacted these amendments to clarify and resolve the long-
standing issues regarding so-called ``takes versus entitlements.'' 
Those issues arose primarily where the amount of natural gas taken 
(``takes'') and sold by a lessee from Federal leases subject to a unit 
or communitization agreement was not equal to the lessee's entitled 
share (``entitlements''), based on its ownership interest in leases in 
the unit or communitization agreement. These imbalances led to numerous 
questions about who should report and pay on what volumes and for what 
leases.
    To obtain input from parties affected by RSFA amendments to FOGRMA 
section 111(k)(1)-(4), MMS formed a consultation team comprised of 
representatives from interested states, oil and gas trade associations, 
and MMS. The consultation team held meetings on October 30, November 
19, and December 6, 1996. The meetings resulted in general agreement on 
definitions, the reporting requirements for 100-percent Federal units 
and communitization agreements, the definition of a ``marginal 
property,'' and how a marginal property reporting exception would be 
determined.
    Subsequent to those meetings, in the process of trying to develop a 
proposed rule implementing RSFA amendments to FOGRMA section 111(k)(1)-
(4), an issue arose regarding the commingling of oil and gas production 
from multiple properties upstream of the point of royalty measurement. 
For purposes of this discussion:
     A ``property'' is defined as a lease, unit, or 
communitization agreement.
     A ``100-percent Federal unit or communitization 
agreement'' means any unit or communitization agreement that contains 
only Federal leases having the same fixed royalty rate and funds 
distribution.
     A ``unit'' means a unit participating area, enhanced 
recovery unit, or field-wide unit.

[[Page 71423]]

     A ``mixed unit or communitization agreement'' means any 
unit or communitization agreement other than 100-percent Federal unit 
or communitization agreement. These are unit or communitization 
agreements that contain any mixture of Federal, Indian, state or 
private mineral estates, or that contain all Federal leases with 
different royalty rates (fixed or variable) or different funds 
distribution.
     A ``stand-alone lease'' means a lease or a portion of a 
lease that is not in a unit or communitization agreement.
    The RSFA cldarly identifies when it is appropriate to initially 
report and pay on a ``takes'' or ``entitlements'' basis for production 
from leases, units or communization agreements that is not commingled 
with production from other properties before the royalty measurement 
point. For instance:
     When taking production from a 100-percent Federal unit or 
communitization agreement, the lessee(s) must pay on actual takes (30 
U.S.C. 1721(K)(1)(A)), or
     When taking production from a mixed Federal unit or 
communitization agreement, the Federal lessee(s) must pay on 
entitlements (30 U.S.C. 1721(k)(1)(B)), or
     When taking production from a stand-alone Federal lease, 
the lessee(s) must pay on takes (30 U.S.C. 1721(k)(1)(C)).
    It is important to note that, while RSFA section 6(d) amended 
FOGRMA by adding section 111(k)(1), which addressed the reporting and 
payment requirements, the addition of section 111(k)(2) went on to 
clarify that the requirements outlined in section 111(k)(1) ``apply 
only to requirements for reporting and paying royalties. Nothing in 
this subsection is intended to alter a lessee's liability for royalties 
on oil or gas production allocated to lease, in accordance with the 
terms of the lease, a unit or communitization agreement, or any other 
agreement.'' Thus, the lessee's ultimate liability to pay royalties on 
its entitled share of production is not changed.
    Commingling adds additional complications to the issue of how to 
report and pay royalties. Not only do imbalances between operating 
rights owners within a property occur, but imbalances between 
properties also are commonplace.
    Commingling is the combining of production from multiple properties 
before measurement for royalty purposes and requires approval of the 
MMS Offshore Minerals Management program for offshore leases or the 
Bureau of Land Management for onshore leases. The commingling approval 
identifies where the volume is measured by royalty purposes and how 
that volume must be allocated to each property that is subject to the 
commingling approval. It does not affect how volume is allocated to 
leases within a unit or communitization agreement. Commingling can be, 
and often is, approved between properties with the same royalty rate 
and funds distribution and between properties with different royalty 
rates or different funds distributions.
    The RSFA provision added to FOGRMA at 30 U.S.C. 1721(k)(1)-(5) does 
not address the effect of commingling or commingling imbalances. 
Commingling complicates reporting requirements because there is an 
impact on royalty payments when there are properties with mixed royalty 
rates or funds distribution upstream of the approved commingling point. 
For example, assume that production from two stand-alone Federal leases 
that are not unitized or communitized, each with a different royalty 
rate, is commingled before the royalty measurement point. Assume that 
each lease receives a 50 percent allocation of the total measure 
production (1,000 Mcf) under the commingling approval. The lessee of 
the lease with a 16\2/3\ percent royalty rate actually sells (takes) 
750 Mcf of gas and the lessee of the lease with the 12\1/2\ percent 
royalty rate actually sells (takes) 250 Mcf of gas. Based on the 
commingling approval, the leases are out of balance. The commingling 
approval determines the volume deemed to have been removed or sold from 
each lease upon which the lessees ultimately must pay royalty. Should 
each lessee pay royalties on its actual sales (takes), the Federal 
Government initially would be paid more than the royalty ultimately 
owed. If the sales were reversed, the Federal Government initially 
would be paid on less than the royalty ultimately owed.
    RSFA prescribes how lessees should initially report and pay royalty 
on production removed or sold from a lease or unit or communitization 
agreement. The commingling approval determines the volume removed or 
sold from the leases or unit or communitization agreements subject to 
the commingling approval. RSFA was silent on the effect of commingling 
approvals. We are asking for your input on several questions regarding 
RSFA's application to production subject to a commingling approval 
before the royalty measurement point. Those questions include the 
following:
    (1) Should lessees of a lease or a 100-percent Federal unit or 
communitization agreement report and pay initially on their takes in a 
situation where production from that lease or unit or communitization 
agreement is commingled with other production upstream of the royalty 
measurement point:
    (2) RSFA requires that Federal lessees in mixed unit or 
communitization agreements report royalties on an entitlement basis, 
regardless of whether the unit or communitization agreement is subject 
to a commingling approval. Should MMS treat a commingling approval as 
the equivalent of a unit or communitization agreement and apply the 
RSFA reporting and payment provisions on that basis? For example, if 
all properties measured at the commingling point are 100 percent 
Federal leases or units or communitization agreements with the same 
fixed royalty rate and funds distribution, then payments could be made 
on takes. If one or more of the properties measured at or after the 
commingling point have different royalty rates (fixed or variable, 
different funds distribution, or are not 100 percent Federal, all 
lessees would pay on entitlements.
    The three examples presented below illustrate some alternative 
methodologies to apply the provisions of RSFA to situations where 
production is commingled before royalty measurement. For each example, 
assume there is a stand-alone Federal lease with two lessees (lessee A 
and lessee B, each of whom owns 50 percent of the working interest), a 
100-percent Federal unit or communitization agreement with two lessees 
(with lessee C owning 75 percent of the combined working interest in 
the two leases, and lessee D owning the remaining 25 percent), and a 
state lease, all of which are subject to a commingling approval. (For 
simplicity, assume that all of the Federal leases have the same royalty 
rate.) Additionally, assume that for each example, the total commingled 
production allocated to the properties is 100,000 Mcf of gas. Further 
assume that, for the month shown in the examples, the stand-alone 
Federal lease and the state lease are each allocated 25 percent of the 
commingled production under the commingling approval, and that the 
Federal unit or communitization agreement is allocated 50 percent. 
Further, assume that lessee A takes and sells 20,000 Mcf of gas. Assume 
that lessee B has no takes. Assume that lessee C takes and sells 30,000 
Mcf of gas while lessee D takes and sells 23,000 Mcf of gas. Assume 
that the lessee of the state lease takes and sells 27,000 Mcf of gas. 
In each example, lessee ownership percentages and liability remain the

[[Page 71424]]

same, but the volume on which royalty initially must be paid varies 
depending on the methology used. (The numbers used in the following 
examples are rounded to the nearest whole number.)

                                                     Example 1--``Pure Takes'' Reporting and Paying
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                                                Allocated
                                               volume per                                                 Entitled share                     Volume on
                  Property                     commingling              Lessee               Ownership     of allocated      Sales by      which royalty
                                                approval                                    percentage     volume  (Mcf)  lessees  (Mcf)    paid to MMS
                                                  (Mcf)                                                                                   (Takes)  (Mcf)
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Federal Lease (2 lessees)..................          25,000  A..........................              50          12,500          20,000          20,000
                                             ..............  B..........................              50          12,500               0               0
100-percent Federal Unit or Communitization          50,000  C..........................              75          37,500          30,000          30,000
 Agreement (2 lessees).                                      D..........................              25          12,500          23,000          23,000
State Lease................................          25,000  ...........................  ..............          25,000          27,000               0
                                            -----------------
    Totals.................................         100,000  ...........................  ..............         100,000         100,000          73,000
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    By using a pure takes methodology, the volume deemed sold and 
removed from each lease and the unit or communitization agreement as 
determined under the commingling approval is not properly accounted 
for. Under this methodology, MMS could be paid on a volume either 
greater than or less than that on which the lessees ultimately owe 
royalty because the takes on which the Federal lessees reported and 
paid royalty would not always equal the volume on which royalty is due 
under the commingling approval. In this example, the MMS would be paid 
royalty on 2,000 Mcf less than the volume on which the Federal lessees 
ultimately owe royalty because under the commingling approval the 
Federal lessees owe royalty on 75,000 Mcf and on a pure takes basis, 
the Federal lessees only paid on 73,000 Mcf. Therefore, adopting this 
methodology presumably would require each royalty reporter to adjust 
royalty payments (at least on an annual basis) to its entitled volume 
(equal to its ownership percentage times the volume allocated to its 
lease or unit or communitization agreement under the commingling 
approval).

                                                 Example 2.--``Pure Entitlements'' Reporting and Paying
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                                                Allocated                                                                                    Volume on
                                               volume per                                                 Entitled share                   which royalty
                  Property                     commingling              Lessee               Ownership     of allocated      Sales by       paid to MMS
                                                approval                                    percentage     volume  (Mcf)   lessee  (Mcf)  (entitlements)
                                                  (Mcf)                                                                                        (Mcf)
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Federal Lease (2 lessees)..................          25,000  A..........................              50          12,500          20,000          12,500
                                             ..............  B..........................              50          12,500               0          12,500
100-percent Federal Unit or Communitization          50,000  C..........................              75          37,500          30,000          37,500
 Agreement (2 lessees).                                      D..........................              25          12,500          23,000          12,500
State Lease................................          25,000  ...........................  ..............          25,000           27,00               0
                                            -----------------
    Totals.................................         100,000  ...........................  ..............         100,000         100,000          75,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Reporting on a ``pure entitlements'' basis that the Federal 
government is made whole with respect to royalties, but would not allow 
for initial reporting and payment based on takes if production is 
commingled before the royalty measurement point. Under this 
methodology, MMS would be made whole each month because lessees would 
report and pay on their entitled volume each month, even if a 
particular lessee (lessee B in this example) took no production. 
Therefore, an adjustment to the entitled volume, as discussed above for 
Example 1, would not be necessary.

                                                Example 3.--``Proportionate Takes'' Reporting and Paying
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                                                Allocated                                                                                    Volume on
                                               volume per                                                 Entitled share                   which royalty
                  Property                     commingling              Lessee               Ownership     of allocated      Sales by       paid to MMS
                                                approval                                    percentage     volume  (Mcf)   lessee  (Mcf)  (proportionate
                                                  (Mcf)                                                                                    takes)  (Mcf)
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Federal Lease (2 lessees)..................          25,000  A..........................              50          12,500          20,000          25,000
                                             ..............  B..........................              50          12,500               0               0
100-percent Federal Unit or Communitization          50,000  C..........................              75          37,500          30,000          28,302
 Agreement (2 lessees).                                      D..........................              25          12,500          23,000          21,698
State Lease................................          25,000  ...........................  ..............          25,000          27,000               0
                                            -----------------
    Totals.................................         100,000  ...........................  ..............         100,000         100,000          75,000
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[[Page 71425]]

    This methodology would combine takes and entitlements by requiring 
lessees to report and pay on volumes equal to the sales by the lessee 
divided by the total sales for the property times the allocated volume 
under the commingling approval for the property. Consider lessees C and 
D: In this example, lessee C would report and pay on 28,302 Mcf, even 
though it actually took 30,000 Mcf, and its entitled volume is 37,500 
Mcf. The 28,302 Mcf is computed as follows:
    (30,000 Mcf/53,000 Mcf) x 50,000 Mcf = 28,302 Mcf for lessee C, 
where 53,000 Mcf (total sales for the property) is the sum of 30,000 
Mcf (lessee C's total sales) and 23,000 Mcf (lessee D's total sales), 
and 50,000 Mcf is the allocated volume under the commingling approval 
for the property. Lessee D's initial reporting and payment would be 
computed similarly.
    Considering lessees A and B: If a lessee took no production (lessee 
B in this example), it would not have to pay any royalty. However, a 
lessee (lessee A in this example) could pay royalty on a volume greater 
than either its actual takes or its entitled share. Under this 
methodology, MMS would be made whole each month because it would 
receive royalty based on the total Federal production subject to the 
commingling approval each month. Therefore, an adjustment to the 
entitled volume, as discussed above for Example 1, would not be 
necessary. In Example 3, lessees would have to adjust their payments 
among themselves.
    As explained above, in instances where a lessee pays on ``Pure 
Entitlements'' such as Example 2, or ``Proportionate Takes'' such as 
Example 3, the lessee may take production that is more or less than its 
entitled share. In that case, a lessee would need to value its entitled 
share. The MMS believes that the best means of valuing the entitled 
share is to apply a volume weighted average of the royalty values of 
the volumes actually taken to the entitled shared volumes. The MMS 
requests comments on any other alternatives for valuing such volumes.
    In addition, MMS is interested in receiving comments on these three 
Examples which describe alternative methodologies. The MMS is also 
interested in receiving comments on any other alternative 
methodologies. If you propose a methodology different from those 
discussed above, please use our example criteria and explain why you 
believe your methodology is the best alternative. In addition, MMS 
would like your input on how the various methodologies would affect 
your business practices, bookkeeping, etc.

    Dated: November 14, 2005.
R.M. ``Johnnie'' Burton,
Assistant Secretary for Land and Minerals Management.
[FR Doc. 05-23380 Filed 11-28-05; 8:45 am]
BILLING CODE 4310-MR-M