American Oil and Gas Reporter - August 2016 - 111

Industry Attacks ONRR Royalty Rules
WASHINGTON-New, ambiguous regulations on valuing oil and natural gas
royalties produced on federal and tribal
lands could harm domestic energy production, warn industry trade groups.
"Many of the provisions in the proposal
are arbitrary and create wide business
and contract uncertainty, and could further
stifle energy production on federal lands,"
assesses American Petroleum Institute
Upstream and Industry Operations Director
Erik Milito. "This rule undermines the
status of the United States as a global energy superpower. Regulatory policies
need to embrace-not discourage-domestic
energy production."
The Department of Interior's Office
of Natural Resources Revenue, which released the final regulations June 30, says
the royalty revisions are necessary to
better align the nation's regulatory framework with a 21st-century energy marketplace. The Consolidated Federal Oil &
Gas and Federal & Indian Coal Valuation
Reform Rule, which becomes effective
Jan. 1, also changes valuation processes
for coal produced from federal and Indian
leases.
Milito says clear, consistent leasing
and royalty terms are necessary for oil
and gas investments. The rule's failure to
achieve the stated goals related to energy
development-combined with the agency's
reversal of many long-standing policies
on valuation options and allowances-
could be a disincentive for energy companies seeking to invest and develop on
federal lands, he contends.
"We keep hearing from the administration that it wants to get 'every dollar
due' from oil and natural gas production
on federal lands. Yet, there are no dollars
due if you drive production off federal
lands by making it too time consuming,
complex and costly," adds Kathleen Sgamma, vice president of government and
public affairs for the Western Energy Alliance. "Small businesses will be particularly hard hit with this regulation, which
disallows normal deductions for the cost
of doing business, charging royalties for
money producers haven't earned."
The rule is available at onrr.gov/laws_r_d/frnotices/pdfdocs/433530.pdf.
Valuations
In revising its regulations for calculating
royalty value for oil sold under an arm'slength contract, ONRR says the new rule
adds notification that the value doesn't
apply if the agency decides to value produced oil under a new default valuation

provision. It also notes ONRR may decide
a lessee's oil value under the default valuation provision if a lessee fails to make
the election when reporting exchange
agreements.
The default provision drew significant
industry criticism, with commenters attacking ONRR's "standardless" discretion,
second-guessing of arm's-length contracts
and other lessee valuations, and a denial
of lessees' ability to deduct all appropriate
costs to reflect value at the lease, the
agency acknowledges.
Other commenters argue against the
agency's ability to determine royalty value
when a lessee or designee sells oil or gas
for 10 percent less than the lowest reasonable measures of market value, the
agency says. Other comments claim some
companies can negotiate better prices
than others, based on their size and bargaining power.
In its response, ONRR states the default provision is a necessary valuation
tool that allows it to determine the correct
amount of oil transportation deductions.
The 10 percent variance the agency may
use in its transaction analysis "is nothing
more than a tolerance to help determine
a proper transportation allowance," it
asserts, and says it continues current
practices.
Industry comments also state it is unclear which ONRR offices (audit and
compliance, enforcement or valuation)
would be authorized to invoke the default
provision, and worry the agency will use
the provision to penalize simple reporting
errors. Commenters complain the default
provision:
* Does not allow ONRR to honor
arm's-length contracts and gross proceeds
as the basis of valuation, as it has in the
past;
* Lacks specific criteria for determining what is reasonable valuation; and
* Is burdensome, an overreach of
valuation authority, and creates uncertainties.
ONRR argues the default provision
revisions are not a radical departure from
previous policies, noting that nothing in
the final rule changes the Department of
Interior's requirement that, for purposes
of determining royalty, crude oil value
from federal leases is determined at or
near the lease.
"The default provision addresses valuation situations where circumstances result in the secretary of interior's inability
to reasonably determine the correct value
of production. Such circumstances include,

but are not limited to, the lessee's failure
to provide documents, the lessee's misconduct, the lessee's breach of the duty
to market, or any other situation that significantly compromises the secretary's
ability to reasonable determine the correct
value," ONRR states.
Deep Water Policy
In the final rule, ONRR says any
movement of bulk production from a
wellhead to an offshore platform is considered gathering, not transportation. The
agency adds this revision replaces its
1999 Deep Water Policy, which allowed
lessees to deduct costs associated with
moving production from the seafloor to
the first platform.
Several oil and gas trade groups opposed rescinding the Deep Water Policy
and the categorical exclusion of subsea
movement costs prior to the first platform,
calling it arbitrary and capricious. They
argued that rescinding the policy penalizes
developing technologies that minimize
surface facilities, reduces environmental
risks and decreases ultimate recoveries.
ONRR says the former Minerals Management Service intended the policy to
incentivize deepwater leasing by increasing
transportation deductions, but that is no
longer necessary.
Misconduct
ONRR says as it is adding a new
definition for the term "misconduct" to
the rule's default provision, indicating
it now includes behavior that does not
need to be willful, knowing, voluntary
or intentional. The new definition differs
from any violations subject to civil penalties under the Federal Oil and Gas
Royalty Management Act of 1982. Industry comments claim this definition
is overly broad, and any common understanding of misconduct implies an
element of intentional wrongdoing. Respondents says they fear ONRR may
expand use of the term to include even
minor occurrences, such as simple reporting errors.
ONRR responds that one legal definition of misconduct describes it as a
failure to perform a duty owed under a
statute, regulation or lease. Consistent
with that definition, it says the final rule
doesn't require behavior to be willful,
knowing, voluntary or intentional to constitute misconduct. The agency states it
only intends to use the misconduct definition for valuation purposes, not for
imposing penalties.
❒
AUGUST 2016 111



American Oil and Gas Reporter - August 2016

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