[Federal Register Volume 71, Number 67 (Friday, April 7, 2006)]
[Proposed Rules]
[Pages 17774-17777]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-5073]


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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.

DATES: You must submit your comments by June 6, 2006. A public meeting 
to solicit further comments will be held in Lakewood, Colorado, on 
Wednesday, May 10, 2006.

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 e-mail. [email protected]. Please include ``Attn: RIN 1010-
AC29'' and your name and return 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;
    By regular U.S. mail. Minerals Management Service, Minerals Revenue 
Management, P.O. Box 25165, MS 302B2, Denver, Colorado 80225-0165; or
    By overnight mail, courier, or hand-delivery. Minerals Management 
Service, Minerals Revenue Management, Building 85, Room A-614, Denver 
Federal Center, West 6th Ave. and Kipling Blvd., Denver, Colorado 
80225.

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. Public Meeting Information

    The MMS previously published a notice in the Federal Register on 
November 29, 2005 (70 FR 228), announcing a public meeting in Houston, 
Texas, on December 14, 2005. That meeting was attended primarily by 
offshore producers. The MMS wants to provide additional opportunity for 
onshore producers to participate in a public meeting. This public 
meeting will be held in Lakewood, Colorado. See IV, Description of 
Information Requested, for details.
    This second meeting will be held on Wednesday, May 10, 2006, from 9 
a.m. to 1 p.m. central time, in the Main Auditorium, Rooms B and C, 
located in Building 85 on the Denver Federal Center located at West 6th 
Ave. and Kipling Blvd. in Lakewood, Colorado. For further information, 
please contact Roman A. Geissel at (303) 231-3226.

II. Public Comment and Meeting Procedures

    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.

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, refer to 
the specific provision, section, or paragraph of statutory law, case 
law, lease term, or existing regulations that you are addressing.
    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, lease 
terms, 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 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 MMS's implementation of section 
6(d) of the Federal Oil and Gas Royalty Simplification and Fairness Act 
(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.
    Due to Denver Federal Center security requirements, attendees at 
the meeting will need a picture ID in order to be admitted onto the 
Denver Federal Center and into Building 85.
    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 
Mr. Geissel 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 website at http://www.mrm.mms.gov/Laws_R_D/FRNotices/FRHome.htm htm, or on request to 
Sharron Gebhardt at (303) 231-3211.

[[Page 17775]]

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.

III. 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 Sec.  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.
     A ``mixed unit or communitization agreement'' means any 
unit or communitization agreement other than a 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 clearly identifies when it is appropriate to initially 
report and pay on a ``takes'' or ``entitlements'' basis for production 
from leases, units, or communitization 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 the 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. Commingling is the combining of production 
from multiple properties before measurement for royalty purposes. Not 
only do imbalances between operating rights owners within a property 
occur, but imbalances between properties also are commonplace. The RSFA 
provisions added to FOGRMA at 30 U.S.C. 1721(k)(1)-(5) do not address 
the effect of commingling or commingling imbalances. Thus, that issue 
must be addressed by rulemaking.
    Commingling 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 for 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.
    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 measured 
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.

[[Page 17776]]

    The 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. The 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 entitlements basis, 
regardless of whether the unit or communitization agreement is subject 
to a commingling approval. When 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 (k)(1)-(4) 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 same, but the volume on which royalty initially must be paid 
varies, depending on the methodology 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)   lessee  (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                        50,000  C............................              75          37,500          30,000          30,000
 Communitization 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
--------------------------------------------------------------------------------------------------------------------------------------------------------

    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 paid only 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

[[Page 17777]]

 
100-percent Federal Unit or                        50,000  C............................              75          37,500          30,000          37,500
 Communitization Agreement (2 lessees).                    D............................              25          12,500          23,000          12,500
State Lease..............................          25,000  .............................  ..............          25,000          27,000               0
                                          --------------------------------------------------------------------------------------------------------------
    Totals...............................         100,000  .............................  ..............         100,000         100,000          75,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Reporting on a ``pure entitlements'' basis ensures 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                        50,000  C............................              75          37,500          30,000          28,302
 Communitization 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
--------------------------------------------------------------------------------------------------------------------------------------------------------

    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 to 
the volumes actually taken to the entitled share volumes undertaken. 
The MMS requests comments on any other alternatives for valuing such 
volumes.
    In addition, MMS is interested in receiving comments on these three 
examples describing 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: March 22, 2006.
R.M. ``Johnnie'' Burton,
Acting Assistant Secretary for Land and Minerals Management.
[FR Doc. E6-5073 Filed 4-6-06; 8:45 am]
BILLING CODE 4310-MR-P