AMENDED MEMORANDUM OPINION AND ORDER
RANDOLPH D. MOSS UNITED STATES DISTRICT JUDGE.
Plaintiff
Continental Resources, Inc. (“Continental”)
extracts natural gas from federally leased land and pays
royalties to the federal government based on the value of the
gas that it sells. From 2003 to 2006, Continental reported
and paid royalties to the Department of Interior's
Minerals Management Service (“MMS”)-a predecessor
to what is now the Office of Natural Resources Revenue
(“ONRR”)-for leases in Washakie County, Wyoming
based on Continental's assessment that it sold its
unprocessed gas to an unaffiliated entity pursuant to an
arm's-length agreement. Following an audit, MMS disagreed
and found that both Continental and Hiland Partners, the
entity that purchased Continental's gas, were owned or
controlled by the same individual, Harold Hamm. MMS,
accordingly, ordered that Continental pay additional
royalties. Continental, in turn, appealed that decision to
the Director of what by then had become ONRR, who agreed that
Continental sold the gas at issue pursuant to a
non-arm's-length contract but concluded that the audit
letter applied the wrong benchmark for determining the value
of a non-arm's-length sale. According to the Director,
Continental should have valued its sale of its unprocessed
gas under a provision of the governing regulation that values
processed gas sold pursuant to a non-arm's length
transaction based on:
consideration of other information relevant in valuing
like-quality [processed gas], including gross proceeds under
arm's length contracts for like-quality [processed gas]
from the same gas plant or other nearby processing plants,
posted prices for [processed gas], prices received in spot
sales of [processed gas], [and] other reliable information as
to the particular lease operation or the saleability of such
[processed gas].
Dkt. 70-32 at 16 (quoting 30 C.F.R. §
206.153(c)(2)).[1] Under another subsection of the
regulation, that value is then reduced by, among other
things, the “applicable transportation allowances and
processing allowances” to arrive at the “value of
production for royalty purposes.” 30 C.F.R. §
206.153(a)(2); see also Dkt. 76 at 13 (Mar. 22, 2019
Hrg. Trans.).
Continental
challenges ONRR's determination on numerous grounds under
the Administrative Procedure Act (“APA”), 5
U.S.C. § 701 et seq., the Mineral Leasing Act,
30 U.S.C. § 181 et seq., and the Due Process
Clause, U.S. Const., amd. V, and the parties have now filed
cross-motions for summary judgment. Dkt. 56, Dkt. 59. Because
ONRR's determination is “plainly . . . inconsistent
with the regulation, ” Bowles v. Seminole Rock
& Sand Co., 325 U.S. 410, 414 (1945), and fails the
APA test of “reasoned decisionmaking, ” Motor
Vehicle Mfrs. Ass'n v. State Farm Mut. Auto Ins.
Co., 463 U.S. 29, 52 (1983), the Court will set the
determination aside and remand the matter to ONRR for further
consideration consistent with this opinion.
I.
BACKGROUND
Pursuant
to the Federal Oil and Gas Royalty Management Act, 30 U.S.C.
§ 1701(a)(2), the Secretary of the Interior has
promulgated a regulation “establishing methods for
determining the ‘value of the production' for
royalty calculation purposes.” Fina Oil & Chem.
Co. v. Norton, 332 F.3d 672, 673 (D.C. Cir. 2003)
(hereinafter “Fina”). “The
regulation establishes three different valuation
methodologies, depending on the particular entity to whom
producers first sell the gas.” Id. at 673-74.
Two provisions are relevant here: 30 C.F.R. § 206.152
(“Section 152”) and 30 C.F.R. § 206.153
(“Section 153”). Section 152 “applies to
the valuation of all gas that is not processed and all gas
that is processed but is sold or otherwise disposed of by the
lessee pursuant to an arm's-length contract prior to
processing, ” 30 C.F.R. § 206.152(a)(1), while
Section 153 “applies to the valuation of all gas that
is processed by the lessee and any other gas production to
which” the regulation “applies and that is not
subject to the valuation provisions of” Section 152,
id. § 206.153(a)(1). Although the two
provisions apply to different types of products, they use the
same three valuation methods, as adjusted to account for the
products at issue.
The
first methodology applies to gas sold to non-affiliated
entities under arm's-length contracts. Unsurprisingly,
this approach values the gas based on the “gross
proceeds accruing to the lessee.” Id. §
152(b)(1)(i); id. § 153(b)(1)(i). The second
methodology applies to gas sold to “marketing
affiliates, ” a term that is narrowly defined to
include only “entities that purchase gas exclusively
from producers that own or control them.”
Fina, 332 F.3d at 674. Under that methodology, the
gas is valued based on the downstream sale by the marketing
affiliate. Id. § 152(b)(1)(i); id.
§ 153(b)(1)(i). Finally, the third methodology values
gas that is “not sold pursuant to an arm's-length
contract, ” other than a sale to a “marketing
affiliate, ” based on one of three benchmarks: (1) use
of the lessee's gross proceeds, if those “proceeds
are equivalent to the gross proceeds derived from, or paid
under, comparable arm's-length contracts;” (2) use
of “other information relevant to valuing like-quality
[gas], including gross proceeds under arm's-length
contracts for like-quality gas[, ] . . . posted prices[, ] .
. . prices received in arm's-length spot sales[, ] . . .
other reliable public sources of price or market information,
and other information as to the particular lease operation or
the saleability of” the gas; or (3) use of “a
net-back method or any other reasonable method to determine
value.” Id. § 152(c); id. §
153(c). Benchmarks (1) and (2), however, apply differently
depending on whether the gas that is sold pursuant to the
non-arm's-length contract is unprocessed or processed
gas. In the case of unprocessed gas, the relevant comparators
are contracts for the sale of unprocessed gas, id.
§ 152(c)(1) & (2), while in the case of processed
gas-referred to in the regulation as “residue gas or
gas plant products”-the relevant comparators are other
sales of residue gas or gas plant products, id.
§ 153(c)(1) & (2).
The
present dispute involves valuation of natural gas that
Continental extracted pursuant to a federal leasehold and
sold between 2003 and 2006 to a natural gas processor, which
ONRR variously refers to as Hiland, Hiland Partners, and
Hiland Partners, LP. Although Continental challenges the ONRR
decision, in part, on the ground that the agency
misidentified, and misunderstood the relationships between,
the various Hiland entities, that question is not relevant to
the Court's decision. For present purpose, the Court
will, therefore, simply refer to “Hiland.” In
paying federal royalties, Continental treated its sales to
Hiland as arm's-length transactions, and it, accordingly,
applied the first methodology discussed above-that is, the
gross-proceeds methodology.
In
2010, however, MMS issued an audit letter concluding that
Continental and Hiland were, in fact, affiliated entities and
that, as a result, the transactions at issue were not
arm's length. See Dkt. 70-32 at 7 (AR 4891).
According to the audit letter, because Continental and Hiland
were under common ownership or control, Continental erred in
applying the gross-proceeds methodology under Section 152(a),
and, instead, should have applied the valuation method set
forth in Section 153(c)(1). Id. at 7-8 (AR 4891-92).
That provision-the first benchmark for processed gas-values
processed gas sold in a non-arm's-length transaction by
looking to “[t]he gross proceeds accruing to the lessee
pursuant to a sale under its non-arm's-length contract .
. ., provided that those gross proceeds are equivalent to the
gross proceeds derived from, or paid under, comparable
arm's-length contracts for purchases, sales, or other
dispositions of like quality residue gas or gas-plant
products from the same processing plant.” 30 C.F.R.
§ 206.153(c)(1). MMS then calculated the corrected
royalty rate using sales invoices provided by Hiland, not
Continental. Dkt. 70-32 at 8 (AR 4892). MMS ultimately
ordered Continental to report and pay $1, 772, 612.07 in
additional royalties. Id.
Continental
timely appealed that decision to the Director of ONRR. The
Director affirmed in part and reversed in part. First, the
Director affirmed MMS's finding that Continental sold gas
to an affiliated entity. The Director then explained that for
Section 152 to apply, “one of two elements must be met:
(1) the gas is not processed, or (2) the gas is processed,
but is sold prior to processing under an arm's-length
contract.” Id. at 13 (AR 4897). Although the
Director did not address the first of these possibilities,
the Court asked counsel to explain what it means to say that
“the gas is not processed, ” and counsel
represented that there are times that natural gas is sold
and used without processing; that is, the gas is
never processed. The Director did address the second
possibility and, consistent with his conclusion that the sale
from Continental to Hiland was not arm's length, he
concluded that Section 152 “is not applicable
here.” Id. at 14 (AR 4898). Because Section
153 applies to “gas that is processed by the
lessee” and to “any other gas production . . .
not subject to the valuation provisions” set forth in
Section 152, and because he had concluded that Section 152
was inapposite, the Director turned to Section 153.
Thus
far, the Director's analysis tracked the audit
letter's. The Director disagreed, however, with the audit
letter's conclusion that the first benchmark was
applicable. He explained that Section 153(c)(1)
“allow[s] ONRR to use the gross proceeds accruing to
the lessee where such gross proceeds are the equivalent to
other gross proceeds derived from, or paid, under comparable
arms-length contracts for processed gas from the same
plant.” Dkt. 70-32 at 15 (AR 4899). Thus, “if
Continental's gross proceeds-not Hiland['s] gross
proceeds-are comparable to other arm's-length sales of
the gas at the tailgate of the Hiland Plant, ONRR could value
Contintental's gas by performing a comparative analysis
of the arm's-length deals.” Id. But that
comparison falls apart on the facts of the transactions at
issue here. As the Director explained,
“Continental's gross proceeds are those derived
from Continental's sale of the unprocessed gas,
” and therefore “ONRR cannot compare
Continental's non-arm's-length sales of unprocessed
gas to other arm's-length sales of processed
gas.” Id. (emphasis added). “In other
words, ” he concluded, “there are no comparable
sales.” Id. And, as a result, Section
153(c)(1) cannot apply.
The
Director concluded that, “[i]nstead, the proper
benchmark in determining the value of the reside gas and gas
plant products is [Section] 206.153(c)(2).”
Id. at 16 (AR 4900). That benchmark uses a:
value determined by consideration of other information
relevant in valuing like-quality residue gas or gas plant
products, including gross proceeds under arm's-length
contracts for like-quality residue gas or gas plant products
from the same gas plant or other nearby processing plants,
posted prices for residue gas or gas plant products, prices
received in spot sales of residue gas or gas plant products,
other reliable public sources of price or market information,
...