[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] ======================================================================= ----------------------------------------------------------------------- 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. ----------------------------------------------------------------------- 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