The opinion of the court was delivered by: Kennedy, District Judge.
This case concerns a dispute over the proper method of valuing gas
resources for the purpose of determining the amount of royalty payments
owed to the United States government. Fina Oil and Chemical Company
("FOCC") and Petrofina Delaware, Inc. ("PDI") (collectively "Fina") claim
that a determination by the Department of Interior ("DOI" or "Interior"
or "Agency") regarding Fina's required royalty payments was arbitrary,
capricious, an abuse of discretion and otherwise not in accordance with
the law in violation of the Administrative Procedure Act ("APA"),
5 U.S.C. § 551, et seq. Before the court are the parties'
cross-motions for summary judgment. Upon consideration of the parties'
motions, the opposition thereto, and the record in this case, the court
concludes that Interior's motion for summary judgment should be granted
and that Fina's motion for summary judgment should be denied.
I. STATUTORY AND REGULATORY BACKGROUND
Interior has delegated the job of collecting royalties to the Minerals
Management Service (MMS), a subagency within the department, which has
promulgated a series of regulations governing the value of natural gas
produced by a lessee. The regulations provide several methods for
calculating the value of natural gas depending on the nature of the sale
of the gas from the, lessee to the purchaser. Under the first valuation
method, if a lessee produces gas which it then sells to a purchaser
pursuant to an arm's-length transaction, the "value of gas sold under an
arm's-length contract is the gross proceeds accruing to a lessee . . . ."
30 C.F.R. § 206.152 (b)(1)(i). The term "gross proceeds" is defined
as "the total monies and other consideration accruing to an oil and gas
lessee for the disposition of the gas . . . ." 30 C.F.R. § 206.151.
This method is known as the "gross proceeds rule."
While the regulations rely primarily on the marketplace to establish
the value of production, Interior recognized that not all gas sales are
made pursuant to arm's-length transactions. Many natural gas producers
have wholly-owned or partially-owned affiliates to which they sell gas.
According to the regulations, arm's-length contracts are limited to
contracts between non-affiliated parties. See 30 C.F.R. § 206.151
(defining "arm's-length contract" as a contract "between independent,
non-affiliated persons with opposing economic interests regarding the
contract"). Thus, by definition, transactions between two affiliated
companies, such as a parent and its wholly-owned subsidiary, are
non-arm's-length transactions. Because non-arm's-length contract prices
may not represent true market value, the regulations provide an
alternative method for calculating value when gas is not sold at arm's
length. See 30 C.F.R. § 206.152 (c). For non-arm's-length sales,
value is determined according to the first applicable of three
prioritized valuation methods, or benchmarks. The benchmarks are
prioritized in the sense that if the first benchmark is found applicable
it is used to calculate value without considering the other two
benchmarks. If the first benchmark is not applicable then the second
benchmark is used, unless it is also inapplicable, in which case the
third benchmark is used.
The regulations also make clear, however, that a lessee's gross
proceeds are always relevant, even when a lessee sells gas under a
non-arm's-length contract. Regardless of the method of valuation used,
"under no circumstances shall the value of production for royalty
purposes be less than the gross proceeds accruing to the lessee for lease
production, less applicable allowances." 30 C.F.R. § 206.152 (h).
Thus, if a benchmark-derived value is lower than a lessee's gross
proceeds, the lessee's gross proceeds will be used for royalty purposes.
See Further Notice of Proposed Rulemaking, Revision of Oil Product
Valuation Regulations and Related Topics, 52 Fed. Reg. 30,826, 30,843-44
(Aug. 17, 1987) (discussing identical language in oil royalty
In determining the lessee's gross proceeds several costs and benefits
are considered. For example, the regulations specify that
[T]he lessee is required to place gas in marketable
condition*fn1 at no cost to the Federal Government or
Indian lessor unless otherwise provided in the lease
agreement. Where the value established pursuant to
this section is determined by a lessee's gross
proceeds, that value shall be increased to the extent
that the gross proceeds have been reduced because the
purchaser, or any other person, is providing certain
services the cost of which ordinarily is the
responsibility of the lessee to place the gas in
30 C.F.R. § 206.152 (i) (1988).*fn2 Thus, if the sale price received
by the lessee is reduced because the purchaser is performing services to
place gas in marketable condition, the value of the services performed by
the purchaser is added to the lessee's gross proceeds in order to
determine the value of the gas for royalty purposes. In other words,
there are certain services the value of which a lessee may not deduct
when calculating its gross proceeds.
For example, suppose a lessee sells nonmarketable gas to another
company for $20, and that company, among other tasks, purifies the gas
for market and then turns around and sells it for $25, where the
purification services increased the value of the gas by $3. The lessee's
gross proceeds are $23: $20 from the sale of the gas plus $3
consideration for the purification services performed by the buyer but
which were not reflected in the sale price paid by the buyer. In the
above example, by reducing the contract price, the lessee in effect pays
a "purification fee" to the buyer in exchange for the buyer agreeing to
perform duties that otherwise would be performed by the lessee. These
services, even if not reflected explicitly in the contract price between
a lessee and a purchaser, will be incorporated into the determination of
a lessee's royalty obligation.
The regulations also identify explicitly the costs that lessees may
deduct when valuing gas for royalty purposes. Lessees may deduct the
costs of transporting gas to distant markets, and also may deduct certain
costs related to processing gas. Sec 30 C.F.R. § 206.156, 206.157
(transportation); 30 C.F.R. § 206.158, 206.159 (processing). If a
lessee produces gas in Colorado pays $5 to move it to Indiana where it
sells the gas for $25, the value of the gas, for royalty purposes, is
II. FACTUAL BACKGROUND AND PROCEDURAL HISTORY
In 1992, MMS conducted an audit of Fina's royalty payments for gas
produced at the "High Island Block 571" wellhead. MMS determined that Fina
was selling gas to FNGC at a non-arm's-length price and that FNGC was
reselling the gas at a higher price. MMS also found that Fina's royalty
payments were based on benchmark values derived from its non-arm's-length
sale price to FNGC rather than on the gross proceeds accruing from FNGC's
arm's-length sale to third-party purchasers. On September 29, 1992, MMS
ordered Fina to base its royalties on FNGC's arm's-length contracts
because MMS considered FNGC to be a marketing affiliate of Fina. See
30 C.F.R. § 206.152 (b)(1)(i) (valuing a lessee's sales to marketing
affiliates according to the marketing affiliate's gross proceeds). MMS
later withdrew that order after it determined that FNGC was not a
marketing affiliate under the regulations because it did not buy gas
exclusively from Fina. See 30 C.F.R. § 206.151 (defining "marketing
affiliate"). However, MMS expanded the scope of its audit to cover all
transactions between Fina and its affiliate.
On May 3, 1993, MMS issued a new order, stating that Fina's royalty
payments should be derived from the gross proceeds of FNGC's arm's-length
sales to unaffiliated purchasers because those sale prices best reflected
the value of the gas. Fina appealed the MMS order. The Agency denied
Fina's appeal on June 7, 1996.
Fina subsequently appealed the Agency's 1996 ruling to the Interior
Board of Land Appeals (IBLA) on August 12, 1996. Fina argued that because
its sales to FNGC were non-arm's-length transactions, the value of the
gas for royalty purposes should be determined according to the system of
prioritized benchmarks established by the regulations. MMS's position was
that the value of the gas was the price received by FNGC pursuant to its
arm's-length sales. According to MMS, had Fina sold its gas directly to
unaffiliated purchasers, it would have charged the same higher price
charged by FNGC rather than the lower sale price contained in the
contract between Fina and FNGC.
On June 11, 1999, the IBLA rejected Fina's appeal. The IBLA ruled that
it was bound by the Board's decision in Texaco Exploration and
Production, Inc., Docket No. MMS-92-0306-O & G [hereinafter Texaco],
which considered issues identical to those presented by Fina on appeal.
In Texaco, Texaco Producing, a lessee of federal oil and gas leases, sold
its oil production to its affiliate, Texaco Marketing, which then resold
the oil at a higher price to arm's-length purchasers after conducting
certain marketing activities. The issue in that case was whether the
value of Texaco's oil should be determined according to the prioritized
benchmarks or according to the gross proceeds resulting from the
affiliate's arm's-length resale. In Texaco, the Acting Assistant
Secretary for the Department of the Interior, with a concurrence from
Secretary Babbitt, ruled that the lessee's royalties should be based on
the affiliate's resale price rather than on a benchmark-derived value, in
part because the price differential between the two values represented a
marketing fee that could not be excluded from Texaco's gross proceeds.
The IBLA adopted the reasoning in Texaco as its own and denied Fina's
appeal. See Fina Oil & Chem. Co., ...