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Devon Energy Corp. v. Norton

August 23, 2007


The opinion of the court was delivered by: Louis F. Oberdorfer United States District Judge


Plaintiff Devon Energy Corporation ("Devon"), a natural gas producer, seeks review of a decision by the Department of the Interior ("Interior").*fn1 Interior held that Devon could not deduct certain costs when it calculated the royalties owed to the government pursuant to its lease to extract natural gas from federally-owned land. Devon principally argues that Interior's decision violates the notice and comment provisions of the Administrative Procedure Act ("APA"), 5 U.S.C. § 553, because it reinterprets Interior regulations in a manner fundamentally different from the agency's prior interpretation of the same regulations. The following analysis establishes that Interior did not reinterpret a prior authoritative interpretation of its regulations in violation of the APA, and hence was not required to conform to the APA's notice and comment provisions.


A. Statutory and Regulatory Background*fn2

Beginning in the 1980s, technological innovations made possible the large-scale extraction of a natural gas variety known as "coalbed methane." Coalbed methane is gas that is trapped in underground coal seams and held in place by hydraulic pressure. To extract the gas, a producer like Devon lifts the pressure on the coalbed, causing the coalbed methane to escape. The gas is then captured and gathered to a central delivery point ("CDP"); removed of any excess carbon dioxide; and dehydrated and pressurized to render it suitable for transport. Only by completing this process does coalbed methane become marketable for use.

The federal government owns land in the Powder River Basin of Wyoming, which is rich in natural gas. It leases rights to extract the gas in exchange for a statutorily fixed percentage of the proceeds.*fn3 Interior, through its subagency the Minerals Management Service (MMS), promulgates rules for the regulation of the relationship between the government and its natural gas lessees, and issues and administers the leases in accordance with those rules.

In 1988 MMS "amended and clarified" the rules "governing valuation of gas for royalty computation purposes." Revision of Gas Royalty Valuation Regulations and Related Topics, 53 Fed. Reg. 1230 (Jan. 15, 1988). These new rules specified that the "value of production" referred to in 30 U.S.C. § 226(b)(1)(A) must be no less than "the gross proceeds accruing to the lessee for lease production," minus certain allowable deductions. 30 C.F.R. § 206.152(h) (1988). A longstanding interpretation of the Mineral Leasing Act (MLA) obligates lessees to put the gas they extract in "marketable condition at no cost to" the federal lessor, thereby precluding deduction of such costs. Id. § 206.152(i); see California Co. v. Udall, 296 F.2d 384, 387-88 (D.C. Cir. 1961) (upholding marketable condition requirement).

Lease products are considered in marketable condition if they "are sufficiently free from impurities and otherwise in a condition that they will be accepted by a purchaser under a sales contract typical for the field or area." 30 C.F.R. § 206.151. If a lessee sells "unmarketable" gas at a lower cost, the gross proceeds for purposes of royalty calculation must be "increased to the extent that the gross proceeds have been reduced because the purchaser, or any other person, is providing certain services" to place the gas in marketable condition. Id. § 206.152(i). To take a simple example, if it costs a producer $20 to put gas in marketable condition by dehydrating and compressing it, and the producer sells the dehydrated and pressurized gas for $100, "gross proceeds" for purposes of royalty calculations is $100, regardless of whether the producer dehydrates and pressurizes and then sells the gas for $100, or instead sells the gas for $80 to a purchaser who dehydrates and pressurizes it.

Importantly, the regulations allow lessees to deduct from gross proceeds costs directly related to transporting the gas from the wellhead for sale at markets remote from the leasehold. See id. § 206.157(a)-(b).

B. Factual Background

The facts of this case are undisputed.

Devon is a producer of coalbed methane and a lessee of the federal government in Wyoming's Powder River Basin. Devon gathers the gas from various wells in the Basin to CDPs, where the gas is measured to calculate the amount of royalty owed to the federal lessor. Pl.'s Stmt of Material Facts as to Which There Is No Genuine Issue ("Pl.'s Stmt") ¶¶ 2-4 (May 4, 2005) [dkt #24].

After being gathered to the CDP, the coalbed methane leaves the CDP through a pipeline to one of Devon's chemical plants, some 126 miles away. There Devon removes the excess carbon dioxide thereby rendering the gas into marketable condition for sale to third parties. To travel the pipeline, however, the gas also must be compressed and dehydrated. As noted above, Interior regulations permit Devon to deduct from their gross proceeds the costs relating to the transport of the gas to the chemical plant. However, the marketable condition rule prohibits deductions of costs necessary to render the gas saleable "under a sales contract typical for the field or area," 30 C.F.R. § 206.151. The regulations do not expressly state whether the costs of dehydrating and compressing coalbed methane are (a) deductible transportation costs or (b) non-deductible costs for rendering the gas into marketable condition. See Pl.'s Stmt ¶¶ 5-10.

In November 1995 Interior convened the Royalty Policy Board to consider how the marketable condition rule should be interpreted with regard to these compression and dehydration costs. In 1995-96, the guidance generated from this meeting was distributed by way of two valuation and reporting Guidelines (the "Guidelines") published on Interior's website, as well as ...

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