American Geological Institute

Government Affairs Program


Royalty Valuation: A Royal Pain for All (10/98)

The following column by GAP Intern Margaret Baker is reprinted from the October 1998 issue of The Professional Geologist, a publication of the American Institute of Professional Geologists. It is reprinted with permission.

In the nearly two years since President Clinton signed the Federal Oil and Gas Royalty Simplification and Fairness Act into law, the Minerals Management Service (MMS) and the oil industry have been engaged in a debate over the development of new royalty regulations. Central to the debate is the choice of a collection system -- whether to take royalties in-kind or in-value (i.e., money). Many in the oil industry support a royalty-in-kind system, but MMS is reluctant to accept all royalties that way, especially in remote regions and from low-yield marginal wells. Many congressional supporters of the oil companies' position have worked to delay proposed MMS regulations and enact royalty-in-kind (RIK) legislation.

What's the Difference?
According to MMS regulations, "a royalty is due when production begins, [and it] represent[s] a stated share or percentage of the amount or the value of the mineral produced." Current regulations require the government to receive royalties in-value based on either gross proceeds - the receipt for sale of oil or gas between a willing independent, non-affiliated seller and buyer - or on benchmarks - a reference price such as a posted price, the price at which a company is willing to buy oil. On the other hand, an RIK program allows MMS to receive the crude oil itself as royalty payment, which the agency would then have to market for revenue. RIK supporters assert that this system would decrease the administrative burden on the agency and simplify the royalty payment system.

MMS Regulations
Several factors played into the timing of MMS's review of royalty regulations. In 1996, the House Government Reform and Oversight Committee released a report entitled "Crude Oil Undervaluation: the Ineffective Response of the Minerals Management Service." The report found that there was a nationwide undervaluation of federal royalties under the current in-value system. During this period, MMS was forced to sue several companies to receive back payments. These actions prompted MMS to change the oil valuation regulations and Congress to enact the Federal Oil and Gas Royalty Simplification and Fairness Act.

In February 1998, after holding 14 public meetings, MMS published its proposed changes to the oil valuation regulations effective on October 1, 1998, the start of fiscal year 1999. The agency stated that "the intent of the rulemaking effort is to reduce reliance on posted prices for royalty valuation, reflect true market value, provide certainty to all involved, and provide maximum flexibility to adapt to changing market conditions." These proposed changes would divide federal lands into three groups for the purpose of royalty valuation: California and Alaska, the Rocky Mountain region, and all other federal lands. Oil and gas royalties from California and Alaska would be based on the Alaska North Slope spot or market prices. In the Rocky Mountain region, several benchmarks would be used, and royalties from all other regions would be based on spot prices for all transactions made "beyond arm's length," an agreement between an independent, non-affiliated oil producer and willing buyer.

Even after public meetings that resulted in several revisions, many in the oil industry still felt that the new regulations were too complex. Citing an increase in uncertainties within the industry and the inclusion of costs associated with marketing in the payment system, industry members say that the new regulations are no better then the old rules and instead embrace an RIK system as the best option.

Congressional Action
In reaction to the MMS rule, Senator Kay Bailey Hutchison (R-TX) introduced an amendment to the Emergency Supplemental Appropriation bill, H.R. 3579, to prohibit the use of federal funds in the current fiscal year for the rule, effectively stalling the implementation of the new rules to allow for more congressional review. In signing the supplemental spending bill, President Clinton stated that he was "very concerned about the limitations placed on the Government's ability to ensure a fair return for oil and gas resources extracted from Federal lands, . . . [and he would] oppose any efforts to make these limitations permanent." MMS, Congress, and the oil industry have been working hard since early May to attempt to pass an RIK bill or, at least, to fix the MMS regulations.

For the past year, the House Committee on Resources has been examining the possibility of an RIK program. In early March, Rep. William "Mac" Thornberry (R-TX) introduced the Royalty Enhancement Act of 1998, H.R. 3334, which would mandate that the federal government take all royalties in-kind, a move that MMS and the White House strongly oppose. After two hearings on RIK, the Subcommittee held a meeting to vote on the bill on June 18, 1998. At the meeting, Rep. Thornberry along with co-sponsor and subcommittee chair Barbara Cubin (R-WY) successfully introduced amendments to clarify language on transportation and processing allowances, as well as to exempt low-yielding marginal wells in remote areas and federal lands in Alaska from the RIK program. The bill passed the subcommittee and is waiting for a financial feasibility report from the Congressional Budget Office (CBO). Thornberry and Cubin have stated that the legislation will not go forward unless the CBO report indicates that the legislation would increase or maintain federal receipts.

Since the subcommittee mark-up in late June, Congress has taken up the unusual role of negotiator between MMS and the oil companies. They have met several times to discuss their differences on the proposed regulations. In an effort to respond to industry concerns, MMS reopened the public comment period on the proposed rules and announced it will revise the rule before October. Senator Don Nickles (R-OK) said in response to the stalemate between the two sides that "this mess makes me think we may need royalty-in-kind legislation."

As the end of fiscal year 1998 draws near, it seems likely that the regulations announced in the Federal Register back in February are not going to be in effect for the 1999 fiscal year. Meanwhile, the RIK legislation is caught in limbo until the CBO compiles a report and, most likely, will not pass both houses of Congress before the November elections. However, with enough pressure in an election year, anything is possible.

______________

Margaret Baker is a senior at Mount Holyoke College in South Hadley MA, where she is double majoring in geology and Asian studies.


This article is reprinted with permission from The Professional Geologist, published by the American Institute of Professional Geologists. AGI gratefully acknowledges that permission.

Please send any comments or requests for information to the AGI Government Affairs Program at govt@agiweb.org.

Posted November 30, 1998


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