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June 11, 2002


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.


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 regulations).

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 marketable condition.

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 $20.


Both FOCC and PDI are affiliated companies that lease natural gas rights from the United States. FNGC is an affiliate of Fina that purchases gas produced by Fina as well as other non-affiliated companies. Prior to 1990, Fina produced gas and sold it directly to purchasers. These sales typically took place at the point of production or "wellhead." In 1990, FNGC was formed as an affiliate of Fina. Fina then stopped selling some of its gas directly to unaffiliated purchasers and began selling it to FNGC, which acted as a middleman by turning around and selling that gas to end-purchasers.

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., ...

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