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March 27, 2003


The opinion of the court was delivered by: Royce C. Lamberth, United States District Judge


This comes before the Court on Chevron's motion for summary judgment [11], the Department of Interior's opposition and cross-motion for summary judgment [16], Chevron's response [19/20], and Interior's reply [22].

I. Background*fn1

Before the natural gas market was deregulated, companies entered into long-term fixed-price contracts for the delivery of natural gas. These contracts were employed for mineral reserves located on federal lands leased to producers ("lessees") under various federal statutes. The contracts provided that the purchasing party would either take the gas at a certain price, or pay the lessee in lieu of taking the production; this is a "take-or-pay" clause. When the market for natural gas was deregulated, the price of gas dropped below the contract price, driving many purchasers to breach their contracts or fall behind on payments under the "pay" portion of the take-or-pay clause. Many lessees and purchasers entered into settlement agreements to resolve several types of contract issues: past-pricing disputes over whether the full contract price had been paid for gas already taken, take-or-pay disputes regarding unpaid "pay" liability, and reformation of the future terms-including price-under which gas was to be taken (if at all). It is the latter that is at issue here.

The terms under which federal land is leased for mineral extraction include the payment of royalties to Interior on the minerals taken from the land. See, e.g., 30 C.F.R. § 206.152, 206.153 (requiring the payment of royalties on gross proceeds from the production of natural gas). When the settlements were first effected, Interior sought to receive a royalty on the settlement proceeds. In Independent Petroleum Ass'n of Am. v. Babbitt, 92 F.3d 1248 (D.C. Cir. 1996) ("IPAA I"), the D.C. Circuit faced a challenge to Interior's efforts to collect royalties on a settlement that was made to resolve past and future take-or-pay liability and in exchange for termination of the contract. After settlement and termination of the contract, the lessee and the purchaser severed their business relationship and the gas that had been the subject of the contract was sold entirely to third parties. IPAA I, 92 F.3d at 1254.

In holding that no royalty was due on the settlement, the D.C. Circuit focused on the statutory language providing that royalties were to be based on the "`amount or value of the production' saved, removed, or sold by the lessee." Id. at 1257. It reasoned that because the payment was not tied to any production-the purchaser received no gas from the producer after the settlement was effected and the contract terminated-the settlement payment did not fall within the statutory scheme and Interior could not assess royalties on it. Unless "funds making up the payment actually pay for any gas severed from the ground," royalties are not due on the funds. Id. at 1260. Thus, IPAA I requires a nexus between a payment and the production of gas.

The next year the Sixth Circuit faced a variation on the IPAA I situation. In In re Century Offshore Management Corp., 111 F.3d 443 (6th Cir. 1997), the lessee accepted a settlement payment from the purchaser to cancel the existing take-or-pay contract and simultaneously replace it with a new contract that did not require a minimum quantity, contained no take-or-pay provision, and provided for a floating rather than a fixed price. Century Offshore, 111 F.3d at 447. The parties continued to do business, and the purchaser "purchased virtually all of the gas identified in the original agreements, within the same time period." Id. The Sixth Circuit found that the two transactions-cancellation of the old contract and execution of the new-were "one transaction for the purposes of the instant [royalty] dispute," and that the situation was "akin to a substituted contract." Id. at 448. Given this business reality, "[t]he lump sum payment behaved as an advance payment under a substituted requirements contract," and consequently "the payment was for `production sold' under the statute, and the royalty was payable when the gas was produced." Id. at 449.

The Century Offshore court specifically acknowledged the requirement of a nexus between a payment and the production of gas, first announced by the Fifth Circuit in Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 1159 (5th Cir. 1988), that had prompted the D.C. Circuit's decision in IPAA I. The court reasoned that when the gas that was the subject of the first contract was taken by the purchaser at the lower price-a price that was reduced because of the settlement payment — the payment was linked with production, and royalties became due on both the settlement payment attributable to the produced gas and the (reduced) purchase price. Id. at 449-50. Century Offshore pointedly noted that IPAA I "addressed a situation in which a nexus with production did not exist." Id. at 451.

II. Analysis

A. Standard of Review

This Court must review Interior's decisions to determine whether they were "arbitrary, capricious, [or] an abuse of discretion." 5 U.S.C. § 706(2)(B). This inquiry requires an examination of "`whether the decision was based on a consideration of the relevant factors.'" Marsh v. Oregon Natural Resources Council, 490 U.S. 360, 378 (1989) (citations omitted); ITT World Comm., Inc. v. FCC, 725 F.2d 732, 742 (D.C. Cir. 1984). If it is determined that the agency did not consider all relevant factors, the court must remand to the agency for additional investigation or explanation. Florida Power & Light Co. v. United States Nuclear Regulatory Comm'n, 470 U.S 729, 744 (1985). The court must assume the agency acted properly. ITT World Comm., 725 F.2d at 742.

B. Contract Buydown Payments

1. Calculating Royalties on Buydown Payments

The parties do not dispute the facts in this case. Chevron entered into numerous settlement agreements with purchasers to amend or replace take-or-pay contracts. A portion of each settlement payment at issue was attributable to the buydown of the contract price for gas.*fn2 Rather than continuing to pay the higher set price contained in the original take-or-pay contracts, upon execution of the replacement or amended contracts, the purchasers were able to take the gas at a price tied to the market value of the gas when ...

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