NATURAL GAS SUPPLY ASSOCIATION

Background: Royalty Valuation

NGSA has been working with MMS for more than three years on developing a new approach to valuing the gas produced on federal leases.

Background and Significance

The current method for valuing gas for royalties relies on the gross proceeds of an individual lessee (or reference for a series of benchmark values). This method was developed when wellhead prices were subject to federal regulation and sales took place at the lease; gas could thus be assigned a value immediately on production. The method no longer works under Federal Energy Regulatory Commission (FERC) Order 636 because today, gas may move many miles away from the wellhead and be bundled with other services before it is priced and sold.

Valuation is significant to producers because most domestic natural gas is produced from leased land. Additionally, some of the richest potential gas finds appear to be on federal land, especially offshore. Furthermore, methods for valuing gas on non-federal lands (such as privately held property or Indian lands) usually track developments in federal royalties.

Valuation is significant to the federal government because royalties are a major source of revenue.

Proposed New Rule

Late in 1995, as the result of a negotiated rulemaking in which NGSA representatives participated, MMS issued a proposed valuation rule that would, as one option, allow producers to value gas based upon published index market prices. The agency, however, after hearing strong objections from a few states and receiving requests for some changes from independent producers, went back to the drawing board and developed some new options. To discuss them, MMS reconvened the negotiation group in June 1996.

Central to independents' objections were fears that the proposed rule would result in a significantly increased chance that smaller producers would be subject to intense audits. MMS's proposed rule calls for a "safety net" that compares the royalties from producers using the traditional gross proceeds methodology--expected to be primarily smaller independents--and producers paying royalties based on published index gas prices, as most producers engaged in downstream markets are expected to do. The "safety net" provides for regional comparisons, not just a comparison of overall results, thus increasing the likelihood of audits for certain producers.

New Consensus

Acknowledging that audits demand a disproportionate share of resources from very small companies, producers attending the June meeting united behind an alternative involving the use of unaudited data. The new consensus would reduce administrative costs for both producers and government and would also permit faster safety-net implementation. State auditors were predictably unhappy about the use of unaudited data, however.

NGSA recommended that MMS finalize the proposal incorporating the new consensus. Failing that, the Association recommended that MMS finalize the proposal as originally drafted.

Another Reversal

Instead, in April 1997, MMS withdrew completely the proposal stemming from the negotiated rulemaking and asked for comments on two completely new proposals. Some in the industry speculated that problems in the collection of oil royalties had created a political climate unfavorable to the release of an industry-supported royalty collection system. Nonetheless, NGSA is vigorously protesting the abandonment of the negotiated rulemaking's outcome. The Association continues to believe that MMS should not retreat from the goal of establishing a workable index-based valuation system that brings the benefits of simplicity, clarity, and reduced administrative burden to the current complex and litigation-ridden royalty valuation methods.

June 1997

---

This page was last updated August 31, 1997.