Issues » Comments on Rules and Regulations

Comments on MMS' Notice of Intent - Federal Oil and Gas Royalty-in-Kind

September 27, 1999 via facsimile (202) 208-3918 and hand delivery

Mr. Bonn Macy
Special Assistant to the Director
Minerals Management Service
1849 "C" Street, N.W.
Mail Stop 4230
Washington, D.C. 20225

Re: Comments on MMS' Notice of Intent - Federal Oil and Gas
Royalty-in-Kind GOM Pilot Program, 64 Fed.
Reg. 37809
(July 13, 1999)

Dear Mr. Macy:

The undersigned trade associations appreciate the opportunity to comment on this important MMS Notice of Intent, the Federal Oil and Gas Royalty-in-Kind Pilot Programs, 64 Fed. Reg. 37809 (July 13, 1999). These associations represent lessees who pay and report federal royalties. As such, they are impacted by the Notice of Intent.

I. General Statement

Industry is committed to working with the MMS in the design and implementation of RIK pilot programs. We appreciate MMS’ willingness to work with Industry to craft workable RIK programs. RIK can be both feasible and have a positive revenue impact on the United States Treasury. Any RIK program should accomplish the following goals:

• a RIK program should provide certainty and minimize disputes between the lessee and lessor. Lessees and the lessor should know with certainty what the royalty payment-in-kind obligation is and that it has been satisfied. Audit burdens for the lessor and lessee should be minimized.
• a RIK program should be capable of compliance by lessees in an efficient and cost-effective manner.
• a RIK program should be capable of being applied to changing market conditions.
• a RIK program should promote simplicity in the royalty management program.

Regulatory uncertainty and increasing changes in the market have resulted in increased disputes over the value of royalty due the federal government. A well designed RIK program would streamline the royalty management process and provide greater certainty and efficiency in the collection of royalties. A properly thought-out and fairly administered RIK program could give the federal government and industry the opportunity to end the cycle of valuation audits, disputes, appeals and litigation and begin a new era of cooperation.

To achieve the goal of certainty, the following essential elements must be the foundation of a RIK program:

• The full royalty share from a lease, unit or facility measurement point must be taken in kind by the Secretary.
• All obligations of the lessee under the lease must be satisfied upon tender of the royalty share to the lessor.
• The royalty delivery point must be at or near the lease or the Facility Measurement Point offshore. Any effort to take or deliver the royalty share at a point downstream of the lease or Facility Measurement Point will add complexity and could add uncertainty with the increased probability for disagreement and disputes.
• The RIK program should commit the lessor and lessee to a RIK program for a reasonable, fixed period of time.
• In accordance with the lease, the lessee must not be required to process the RIK royalty gas prior to delivery except in limited circumstances upon the agreement of the lessor and lessee.
• If the Secretary takes delivery at a point other than at the lease, the reasonable costs of transportation are due to the lessee.
• Any issues related to the method of handling imbalances should be agreed upon prior to RIK deliveries being made.
• Reporting and audits should be limited to only the volumes delivered/taken and any transportation expenditures.

II. Statutory Issues

A. Desirable Legislative Changes to the Outer Continental Shelf Lands Act

The Outer Continental Shelf Lands Act ("OCSLA") provision for the purchase of federal royalty oil and gas. 43 U.S.C. ' 1353 (b) states:

the Secretary, except as provided in this subsection, may offer to the public and sell by competitive bidding for not more than its regulated price, or, if no regulated price applies, not less than its fair market value . . .[T]he Secretary may dispose of any oil which is taken as a royalty or net profit share accruing or reserved to the United States pursuant to any lease issued or maintained under this subchapter, or purchased by the United States pursuant to subsection (a)(2) of this section, by conducting a lottery for the sale of such oil, or may equitably allocate such oil among the competitors for the purchase of such oil, at the regulated price, or if no regulated price applies, at its fair market value.

1. OCSLA definition of "fair market value"

The OCSLA defines "fair market value" as:

"[T]he value of any mineral (i) computed at a unit price equivalent to the average unit price at which such mineral was sold pursuant to a lease during the period for which any royalty or net profit share is accrued or reserved to the United States pursuant to such lease, or (ii) if there were no such sales, or if the Secretary finds that there were an insufficient number of such sales to equitably determine such value, computed at the average unit price at which such mineral was sold pursuant to other leases in the same region of the outer Continental Shelf during such period, or (iii) if there were no sales of such mineral from such region during such period, or if the Secretary finds that there are an insufficient number of such sales to equitably determine such value, at an appropriate price determined by the Secretary."

In the joint MMS/Industry paper on the 1995 MMS Gas RIK Pilot, the authors stated:

"[g] Legal restraints in the Outer Continental Shelf Lands Act (OCSLA) 43 U.S.C. 1351, et seq.

There were concerns that the OCSLA provision regarding fair market value would preclude MMS from taking its offshore royalty gas in kind in a manner envisioned in the pilot. Specifically, Section 27 of the OCSLA requires that, if the Secretary exercises the right to take gas in kind, it must be done in such a manner that the price received is not more than the regulated price, or, if no regulated price applies, not less than its fair market value. Because of the way the OCSLA defines fair market value, this could be interpreted to mean that the Department, on a lease-by-lease basis, must make some sort of comparison to lessees' sales to determine if fair market value has been received for royalty volumes taken in kind. The basis for valuing lessees' sales would be as defined by the 1988 valuation regulations.

Because the pilot is a one-time test of a concept being included as part of the Vice President's National Performance Review and overall "fair market" impacts could be considered prior to awarding contracts, MMS was able to move forward with the pilot while researching legislative and regulatory alternatives."

The authors of this paper questioned what the "fair market value" standard actually meant. These authors also questioned MMS’ ability to meet that standard.

In its September 1996 Report on the royalty Gas Marketing Pilot, MMS stated:

"The SOL [Office of the Solicitor] has advised MMS that we may need to promulgate regulations before we can institute a permanent program to take our gas royalties in kind. In addition, it has stated that OCSLA "fair market value" provisions may preclude us from proceeding with a new pilot or program without a change in the OCSLA or a regulatory clarification of this provision's meaning (see page 5, Appendix 2)."

It should be noted here that the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996, introduced as H.R. 1975 and S. 1014, originally contained a provision (Section 10) which would have amended the OCSLA and MLLA RIK provisions. MMS supported the RIK provisions of H.R. 1975 and S. 1014. Specifically, in a written statement about the RIK language in H.R. 1975, MMS said:

"The bill [H.R. 1975 Section 10] language amends language of the OCS Lands Act in a manner that will improve the MMS' ability to administer its current and future NPR RIK Gas Marketing Pilot. The bill also limits the lessee's record-keeping requirements related to royalty paid in kind. Basically, the lessee must only keep records for MMS inspection that are related to volumes of oil or gas produced and delivered."

The MMS states in its Notice of Intent that "in those instances where it is not possible, practical, or equitable to determine contemporaneous with an RIK sale average prices from a lease or the region, we believe we can reliably estimate these values very closely." (64 Fed. Reg. 37812). The methodology MMS would use to estimate values is not explicitly delineated in the Notice of Intent. The absence of a clearly delineated methodology for determining what constitutes "fair market value" makes certainty difficult to achieve for the MMS or lessees. MMS should describe its proposed methodology before proceeding.

In addition, MMS states that "to verify that the pricing relationship between lessees’ sales prices and the market continues, MMS will require occasional reporting by lessees of sales prices on leases from which MMS is taking production in kind." (64 Fed. Reg. 37812). This imposes the potential for an additional, undefined, reporting burden on lessees without a clear objective or compliance with the Paperwork Reduction Act ("PRA") provisions.

2. Restraints of "competitive bidding" requirements

The OCSLA requires that offshore RIK production be sold "by competitive bidding for not more than its regulated price, or, if no regulated price applies, not less than its fair market value". (43 U.S.C. 1353 (b)(1) and (b)(2) (1998). As MMS states, "one objective of the pilots is to evaluate the relative merits of different bidding methods so we can identify the most effective and appropriate ways for the government to secure a competitive market price for our public assets, as we are required to do by law. In offering RIK production for sale to the public, we intend to consider using any bidding procedure or format that brings us the best return in open and competitive sales." (64 Fed. Reg. 37810).

The MMS has identified the need to provide more flexibility to the Secretary’s ability to dispose of RIK gas. Based upon the lessons learned in the 1995 Gulf of Mexico Gas RIK Pilot as reported by MMS in its September, 1996 Feasibility Study and the report of the OIG, an RIK program would benefit substantially if the definition of "fair market value" were changed to a more workable, practical definition or the current OCSLA definition did not apply to RIK oil or gas.

2. Obligations of the Operator in an RIK Program Should Be More Clearly Defined by an Rulemaking.

The Notice states that "a primary responsibility of the operator will be to deliver the royalty production to MMS in "marketable condition" as is currently required by the lease and regulations for payment of royalties in value. Operators are expected to use the same measurement and reporting standards applicable to the payment and reporting of royalties in value." (64 Fed. Reg. 37811). Neither the lease agreement nor the MMS regulations require the Operator (as opposed to the lessee) to deliver royalty production in "marketable condition".

The Notice states that "the managing operator of the project will be an active participant in the transaction." (64 Fed. Reg. 37811). It is entirely unclear what "active participant" means in this context. There is an implication of responsibility without any delineation of legal relationship and duty. Further, neither the lease agreement between the lessee and the United States nor the regulations require such participation on the part of an operator. Any attempt to expand the operators’ duties to include obligations which are not set forth in existing statutes and regulations would be inappropriate.

The imposition of RIK burdens without the requisite notice and comment period afforded by a rulemaking and a PRA analysis could be detrimental to the fundamental goals of a successful RIK program. Care must be taken not to confuse or intertwine the leasehold obligations of a lessee with an obligation imposed on an entity who operates wells on federal lands. The royalty payment obligation is the sole obligation of the lessee under the lease contract. Under most joint operating agreements, it remains the obligation of the lessee. A rulemaking, with notice and comment would permit proper analysis and resolution of the roles of the lessee versus lessor versus operator. There are other issues relating to the lessee/operator responsibilities that should be specifically addressed. MMS may want to consider issuing a "Dear Lessee" letter as well as a "Dear Operator" letter.

3. Obligations of the Lessee in an RIK Program Should Be More Clearly Defined by an APA Rulemaking.

1. Delivery of royalty gas/oil by the lessee satisfies its royalty obligation.

The concept that delivery of the royalty share in kind satisfies the royalty obligation needs to be explicitly provided for in the GOM RIK Gas Pilot. While it appears that MMS agrees with this important concept, its Notice of Intent does not explicitly provide for it. Lessees need the certainty of knowing that delivery of the royalty share will satisfy in full the royalty obligation for the applicable lease(s) and that the lessee is not at risk of retroactive value or price adjustments subsequent to the month of delivery.

One of the major advantages of a royalty in kind program versus royalty in value is that a properly-designed RIK program should reduce, if not eliminate, the valuation issues currently in dispute. Such a program would provide lessees with the certainty they need to conduct their business. Once a lessee has delivered the royalty share in kind (as verified by MMS) the royalty obligation would be satisfied and not be subject to later audit, dispute and litigation as is the case under the current royalty in value system.

It appears MMS concurs with this premise as is evidenced by the "Dear Operator" letters issued in connection with the first two RIK Pilots initiated in 1998. The Dear Operator letter for the Wyoming Oil RIK Pilot, dated February 12, 1999, states (at page 2): "Delivery of the accurate volume of Royalty Oil (taking into account the effects of normal operational imbalances) in accordance with the terms of this letter will satisfy the Lessees' royalty obligation to the Lessor." (Emphasis added.) In the Dear Operator letter for the Texas 8(g) Gas Pilot, dated October 14, 1998, MMS states (at page 1): "Delivery of the accurate royalty share of natural gas produced from the lease will satisfy the lessee's monthly royalty obligation under the lease." (Emphasis added.) Any "Dear Operator" letter for the Gulf of Mexico Pilot should contain similar language.

Once royalty in kind is delivered, the lessee has fulfilled all its lease obligations. When the government takes its royalty in kind, it should not conduct a comparison with what proceeds it believes it might have received under the application of regulations for royalty in value. The lease states that the Secretary shall receive royalties in value or in kind, not both. To do otherwise would be to defeat one of the main purposes of RIK – reduce administrative and reporting burdens on both MMS and industry.

D. Obligations of DOI/MMS

• Delivery Point

Most, if not all OCSLA leases provide that the Secretary will take RIK at the lease or at a "more convenient" location onshore. Both lessor and lessee agree that applicable statutes and leases provide that royalty be valued at the well or lease. Therefore, MMS should establish the Delivery Point for RIK at the Facility Measurement Point to eliminate the uncertainty (and potential litigation) inherent in the valuation of transportation allowances or other downstream charges. One of the valuation issues currently in dispute is what is the appropriate value of transportation services which a lessee is allowed to charge the federal government. If MMS is allowed to direct lessees under any RIK program to deliver the royalty share at a location downstream of the well or lease, the parties will perpetuate at least one of the primary valuation issues in dispute and cause both the lessee and the MMS to continue to operate in an uncertain environment. If MMS establishes the Delivery Point for RIK purposes at the well or lease, i.e., the FMP, this dispute and the resulting uncertainty can be avoided.

The value of production for royalty purposes is the value of the oil or gas at the lease. An effective RIK program will measure value appropriately by looking to a transaction between a willing buyer and a willing seller at or near the lease. RIK provides a definitive answer to the question of what is the value at the lease. Royalty value is what the MMS will receive from its willing purchaser for the product delivered at or near the lease. One of the significant benefits will be that neither the lessee nor lessor will be requested to account for the complexities of costs incurred away from the well. Establishing any RIK delivery point downstream of the facility measurement point would add unacceptable complexity to the payment of royalty in kind. Disputes, appeals and litigation would likely arise regarding which costs must be shared by the lessee and lessor, and those which must be borne exclusively by the lessee.

A typical offshore lease agreement states:

"When paid in amount, such royalties shall be delivered at pipeline connections or in tanks provided by the Lessee. Such deliveries shall be made at reasonable times and intervals and, at the Lessor's option, shall be effected either (i) on or immediately adjacent to the leased area, without cost to the Lessor, or (ii) at a more convenient point closer to shore or onshore, in which event the Lessee shall be entitled to reimbursement for the reasonable cost of transporting the royalty to such delivery point."

A reasonableness standard must be applied to the lessor's choice of a "more convenient" delivery point. Literally read, the "more convenient point" would be either the first interconnect into an interstate pipeline or the first point onshore. Care must be taken in determining what constitutes a "more convenient" location.

2. Transportation

a. Discriminatory Reimbursement of Transportation Costs:

The lease provides that when the Secretary takes RIK at a place other than the lease, the Secretary will pay the lessee for "reasonable transportation". If lessees who are affiliated with the transporter are reimbursed based on cost recovery, as opposed to "commercial" or "reasonable" transportation rates, these lessees would essentially bear a higher royalty burden than co-lessees who are not affiliated with the transporter. This scenario could alternatively be seen as MMS imposed royalty on transportation. For potential bidders on RIK sales who are affiliated with transporters, their bids will be adversely impacted if their royalty expense is higher due to inability to receive "commercial" rate reimbursement for transportation costs. In the past (prior to the 1988 regulation), the MMS has allowed a pipeline-affiliated lessee to deduct the transportation allowance based on what similarly situated non-affiliated lessees were allowed.

b. Contrary to OCSLA Intent:

The OCSLA addresses the issue of pipelines and discrimination -

". . . upon the express condition that oil or gas pipelines shall transport or purchase without discrimination, oil or natural gas produced from submerged lands or outer Continental Shelf lands in the vicinity of the pipelines . . . [43 USCA ' 1334(e)] and

"The pipeline must provide open and nondiscriminatory access to both owner and nonowner shippers." [43 USCA ' 1334(f)(1)(A)]

The intent of the OCSLA is to prevent discrimination among pipeline shippers, yet MMS transportation allowance/reimbursements would be discriminatory. A federal lessee has no obligation to deliver RIK gas production to a downstream point free of cost. Rather the lessee’s obligation is merely to place the gas in marketable condition. Under our lease agreements, a lessee is clearly entitled to reimbursement for reasonable transportation costs associated with RIK delivery.

          a.  Reasonable Transportation Costs

If RIK is taken downstream of the lease a variety of issues related to reimbursement of transportation costs must be addressed. The federal lease agreements involved in the Pilot provide for the reimbursement to the lessee of "reasonable transportation costs." Thus, the reimbursement of anything less than the Lessee's "reasonable transportation costs" would be a violation of the lease agreement.

Secondly, any provision in a "Dear Operator" letter that transportation costs will be reimbursed pursuant to the regulations at 30 CFR part 206 is inappropriate. By their terms, these regulations apply only to the calculation of transportation costs when royalty is paid in value. These regulations have no applicability to RIK deliveries. Further, the calculation of a transportation reimbursement pursuant to these regulations would not result in the reimbursement of all "reasonable" transportation costs under many RIK situations and as is expressly required under the lease agreement. For example, the federal government should share in any penalties that lessee incurs as a result of the lessor taking its royalty in kind. This is contemplated in the draft "Dear Operator" letter under "Lessor Obligation to Take" when it says "You will incur no penalties if, through no fault of your own, the Lessor or its purchaser fails to take 100% of the royalty gas." Not taking enough gas is not the only situation where penalties can occur.

3. The Secretary’s Take Obligation.

If the lessor takes any of its royalty in kind from a lease, it should take its full royalty fraction in kind. As consideration for a bonus and a royalty free of production costs, the lessor has given up its right to operate the lease. Lessor has no right under the lease to defer its obligation or leave its production in the ground, nor does the lessor have the right to take a portion of production in kind and the remainder in value. Otherwise, lessees will be unfairly burdened by having additional production, operating, marketing and balancing problems with which to contend. Administrative efficiency for both lessor and lessee can only be maximized if the burden and complexities of royalty in value eliminated for all of the royalty stream from a lease.

We appreciate the MMS' acknowledgment that it will take 100% of the royalty gas delivered at the Delivery Point for the entire term of the program. Though probably implicit, we would appreciate the MMS' express acknowledgment that it will take such gas on a daily basis as delivered by the Lessee.

4. Once Taken in Kind, the Secretary Will Have All Right, Title, Interest, and Risk in the Production

When a lessee tenders RIK production at the delivery point, it is actually delivering to the lessor and performing under its lease agreement. The purchaser who takes delivery at the RIK delivery point is actually taking from the lessor and performing under a separate contract with the lessor, the RIK sales contract. The lessee and the lessor's purchaser have no contractual relationship with each other. There is concern that operational impacts may be felt by the purchaser, marketer and producer. An effective RIK program should not hold the lessee liable for the purchaser's failure to perform under the RIK contract, nor should it hold the purchaser liable for the lessee's or operator's failure to perform under the lease contract. In addition, the lessor cannot expect parties who have no contractual relationship to work out certain issues among themselves as if they could enforce contracts on behalf of the lessor. For example, at 30 CFR 208.8(b) the provision "quality differentials between the royalty oil to which a purchaser is entitled and oil which is made available at the delivery point are matters to be resolved between the purchaser and the operator", not only illustrates the inefficiencies which result from establishing the RIK delivery point downstream from the lease, but fails to recognize the fact that lessees and operators do not have the ability to require a purchaser under an RIK contract to perform, and vice-versa. In an effective RIK program, the lessor must ensure that the parties whom it has brought together under separate contracts actually perform their respective obligations, even when the recipient of the performance is a party who is merely standing in the shoes of the lessor.

5. Processing

For royalties paid in value, the lease agreement does not obligate the lessee to anything beyond delivery (movement or transportation) of the royalty at the lease or at a more convenient point. If delivery of RIK gas should be required by MMS at the tailgate of a plant, the lessee would be required to enter a processing agreement. This defeats the identified goals of decreasing the need for extensive reporting, verification, and auditing of lessee records, and improved certainty and administrative efficiencies. Plant processing agreements are contracts between producers and the operators/owners of plants. To the extent that the lessor elects to take its royalty gas in kind, the lessor, its agent/marketer or its purchaser will have to make its own processing arrangements.

The concept of requiring the lessee to process RIK gas prior to delivery is not in the statutes, lease agreement or regulations. Any requirement to process gas would constitute a violation of the lease agreement.

6. Marketable Condition

MMS Notice of Intent (64 FR 37809, July 13, 1999) states:

"A primary responsibility of the operator will be to deliver the royalty production to MMS in "marketable condition" as is currently required by the lease and regulations for payment of royalties in value. ... It will continue to be the lessee's obligation to perform and bear all costs of gathering, dehydration, separation, compression, sweetening, or other processes that MMS will require in connection with the delivery of RIK production." [at 37811]

It is the lessee’s not the operator’s responsibility to place royalty production in marketable condition. If delivery of the gas is away form the lease, the proper term is placement of royalty production in marketable condition because the term deliver could be construed to as meaning a lessee must transport it free of charge. Further, it must be clarified that the costs of compression, dehydration or any other service associated with transportation should be reimbursed costs.

III. Operational Issues

A. MMS should provide operational certainty under an RIK program to achieve the optimum results.

Any RIK Pilot should contain the following provisions to provide the operational certainty the lessor and lessees need for a smooth running program. Here is a summary of them.

• Each month of the program, MMS (or its purchaser/agent) will take 100% of the RIK volumes delivered by the lessee. See Wyoming Oil RIK Pilot Dear Operator letter (at page 3). MMS will take all royalty production from applicable leases/units. See Notice of Intent at 37811.

• Lessees will deliver RIK volumes at the same frequency as lessees' volumes are produced, except where otherwise approved by MMS. See Notice of Intent at 37811.

• A lessee will incur no penalties, [nor be ultimately held responsible for any damages or losses it incurs or any penalties imposed by third parties], as a result of MMS' purchaser/agent's failure to take 100% of the royalty volumes. See Wyoming Oil RIK Pilot Dear Operator letter (at page 3).

• MMS will give a minimum 45-day notice (and preferably 60 days) to lessees of its intent to take production in kind (or stop taking in kind) from a given lease. See Notice of Intent at 37811. Lessor needs time to develop lease data for bid packages. Marketers need time to develop the bids. Lessee’s need sufficient lead time after a bid is accepted to prepare for in kind payment of royalties. At termination, the lessee needs lead time to include the royalty share in its marketing program. Lessees also need lead time to change systems to pay royalty in value.

• Once MMS determines to take its royalty share in kind, it will do so for a time certain (such as the Winter season - November through March). These commenters strongly believe that the program would be significantly benefitted by the Secretary taking during the seasons established by the market and not switching back and forth during a single season.

1. Lease Selection and Location.

a. Aggregation of Volumes. It would seem to make sense for the lessor to aggregate large volumes either for itself or its marketer to sell in order to maximize the price to be received. In order to aggregate sufficient volumes, lessor should take all production from a given area, e.g., the Gulf of Mexico (or a designated portion of the Gulf of Mexico). It may also make sense for lessor to consider taking all RIK volumes based on production tied to a certain pipeline or pipelines in a particular area.

b. Once an Area is Selected, All Leases Should Tender RIK. Once an area is chosen, it makes sense for the lessor to take from all leases within that geographic area. Leases should not be involved in RIK on a company basis, but rather on an area basis. If a lessor has royalty interests in a given unit, it should take all the production it has an interest in, not just the interest associated with a single producer. Lessor should take on a lease-wide basis and from an entire pooling agreement in order to reduce accounting problems and their effects.

2. Participation

From an operational and administrative standpoint, a RIK program should seek full participation for a given area (i.e., all working interest owners in leases for a given area should participate). Otherwise, there is a risk of establishing two separate accounting systems under a single lease, which can only lead to problems. There may be a need for flexibility or exceptions to be built in for producers who have fixed contractual obligations or other contractual requirements that lessor's taking of RIK volumes may severely impact.

3. Contractual and Bidding Issues

Not only does the lessor need to develop timely lease data for the bid process, but it also must develop a complete bid package which details issues such as lateral lines and contacts at various companies for information and agreements (recognizing that, in many cases, different types of agreements may be handled by different individuals within a company). The lessor needs to collect all of the pertinent lease and production data and provide it as part of the bid process so that lessees do not have to answer the same question multiple times from all the different bidders.

4. MMS Should Not Make Retroactive Adjustments

MMS should not be able to make retroactive adjustments (i.e., bill purchasers or lessees retroactively) based on MMS' later determination that higher prices or royalties were owed on the royalty share of production delivered in kind. This concept needs to be explicitly provided for in connection with the GOM RIK Gas Pilot. MMS expressly agrees with this concept, at least as it applies to purchasers. MMS states in its Notice of Intent, published July 13, 1999:

In theory, we could require that all RIK purchase prices be subject to post-sale adjustments when the lease price information becomes available to MMS. In our view, this would be excessively burdensome to all concerned and would effectively discourage, if not eliminate, participation in RIK sales...It is clear that such a process would not only be inequitable to potential purchasers, but could not effectively capture a fair market value. . . .

64 Federal Register 37809, 37811 (emphasis added). These same arguments should be equally applicable in making a case against allowing retroactive adjustments against lessees. While not as explicit here, MMS does indicate that the pricing data which it may periodically require of lessees will not be used making post-delivery royalty adjustments: "These reported prices would only be used for information and analytical purposes, are necessary to assure that we continue to receive fair market value for RIK sales, and will not be available for any other use." 64 FR at 37812 (emphasis added).

B. Balancing Entitled Volumes to Volumes Actually Taken

1. Lease Level Imbalances

Imbalances should be determined for each lease/unit based on the difference between the royalty share of production and actual takes metered at the FMP and allocated to the lease when commingling is involved. A Lease/Unit operator should provide the lease/unit imbalance statement to the MMS 60 days after the month of production.

Imbalances remaining upon cessation of royalty in kind or cessation of production should be settled based on the nearest index for the pipeline that receives the gas. The index netted to the lease, for the final month of delivery should be used to value the imbalance. The applicable over or undertaken owners should report the imbalance volume and value on the Form MMS-2014 as either a positive or negative for the final month of delivery. Interest should accrue from 30 days after the receipt of the gas imbalance statement for the final month of delivery.

2. Imbalances Downstream of the Lease

Imbalances which occur downstream of the lease and prior to the delivery point, should be treated as part of transportation. As an example, normal "cash-out" of these imbalances by third party transporters should be netted with the monthly transportation cost reported on the Form MMS-2014. Transportation imbalances which are not "cashed out" monthly by a third party transporter should be made-up by adjusting nominations in a subsequent month.

Normal volumetric transportation imbalances remaining at cessation of royalty in kind or production should be settled in accordance with any third party transportation agreement or in the absence of agreement, based on the nearest pipeline index. Imbalances should be reported as a positive or negative on the MMS-2014 by the producer who transports the RIK gas on behalf of the MMS for the final month of RIK or production from the lease/unit.

3. Balancing Account and Imbalances

As a practical matter, important issues such as balancing methods should be agreed upon between the MMS and the taking parties before the RIK deliveries are made so that all parties have an up front understanding of their rights and obligations. Neither party should be able to unilaterally modify the balancing method. Industry standards and existing balancing agreements should be the model for any balancing arrangements agreed upon by the Lessor and the taking parties. Since the MMS will be taking on the role of a commercial market participant by taking and marketing its royalty in kind, it should act accordingly and realize that an up front agreement on such issues provides certainty and efficiency for all parties involved.

C. Nominations and Scheduling

Nominations in a subsequent month should be adjusted to provide for volumetric makeup of the monthly imbalances.

D. Adequate Notice to Lessees to Take In Kind and Adequate Notice to Return to Payment in Value

The period for which the MMS will take its royalty in kind needs more definition. If the lessor takes its production in kind, it should be committed to RIK for a certain fixed length of time and must not precipitously move in and out of an RIK program for any given lease. It would be extremely helpful for a lessee's planning and administrative purposes if the MMS would provide an "earliest" ending date. Further, the MMS should commit itself to provide the lessee at least a minimum of forty-five (45) to sixty (60) days prior written notice of termination, anything less than that can disrupt planning for transportation and sales of the lessee's share of production which would include the federal royalty share since royalty is now to be paid in value. Administrative efficiency can best be realized if, once royalty is taken in kind, the lessor is required to maintain the RIK program for a substantial length of time. To require lessor's and lessee's to re-enter the complexity of royalty in-value would contravene the goals of certainty and streamlining of the royalty management program.

IV. Assessment of RIK Pilots

It seems particularly important to identify the framework and criteria for judging the revenue impacts of this pilot before the pilot begins. Industry is willing to work together with the DOI/MMS to develop a model or criteria to assist in analyzing the values received by the government when taking RIK gas. Industy has expressed an interest in participating with MMS in understanding and accurately estimating the revenue impact of all RIK Pilots and in particular the proposed GOM RIK Gas Pilot. Prior to the initiation of any pilot resolution of these important issues is necessary.

V. Summary

The undersigned associations appreciate the opportunity to comment on this important Notice of Intent and look forward to continuing to work with MMS on its pilot programs. We would request that MMS revise and reissue the Notice of Intent to address these comments. We believe royalty-in-kind can benefit all parties concerned and are committed to working with the MMS and States to develop a successful RIK program. Please call if you have any questions or if we can be of assistance.

Sincerely,

American Petroleum Institute
Domestic Petroleum Council
Independent Petroleum Association of America
Independent Petroleum Association of Mountain States
United States Oil and Gas Association

cc: Dave Rostker    

Desk Officer for the Department of the Interior

Office of Information and Regulatory Affairs

Office of Management & Budget

Washington, D.C.