MMS amends oil valuation rule; draft gas rule pending

The US Department of the Interior's Minerals Management Service last month amended its federal oil valuation rule and said it plans to revise the gas royalty valuation soon.

MMS officials said that the revised oil rule reflects changes in energy market conditions and trends. They also think the new rule will reduce industry lawsuits because the regulation clarifies past points of dispute such as transportation allowances.

In its latest action, MMS switched from an index spot price benchmark to a valuation based on the New York Mercantile Exchange for oil sold between two related parties (nonarm's length contracts).

The rule goes into effect July 6.

In an interview May 5 on the sidelines of the Offshore Technology Conference in Houston, MMS Director Johnnie Burton said she expected to release a proposed gas valuation rule within 2 weeks.

MMS officials said that the current draft, which will be subject to extensive comment from industry, states, and other stakeholders, revises transportation allowances and cost-of-capital deductions to be consistent with the new oil rule. But unlike the oil rule, it largely leaves in place the current benchmarking system and does not switch to NYMEX as a way to determine gas value (OGJ Online, Apr. 22, 2003).

Natural gas traditionally accounts for more than 60% of the agency's federal petroleum royalty revenue. And the royalty money MMS generates is important for federal and state budgets that often face shortfalls.

Changes to oil

Crude oil produced from federal leases in California and Alaska will continue to be valued using Alaska North Slope spot prices for oil that is not sold at arm's length. Price adjustments will be allowed for locality and quality differentials. MMS also clarified transportation allowances that reduce the amount of royalties companies pay MMS and states with federal leases.

The agency also revised cost of capital calculations. For nonarm's length sales, the rules raised the rate of return on undepreciated capital from 1 times the Standard & Poor's "BBB" bond rate to 1.3 times the "BBB" bond rate; MMS said the change better reflects the industry's actual cost of capital. MMS said that the changes will not mean revenue losses for the US Department of the Treasury or for states.

Reactions

Industry generally was supportive of the agency's proposals, while a lawmaker who frequently criticizes MMS policy faulted the rule. State governments, meanwhile, said they were still reviewing the regulation, although some attorneys that have disagreed with industry in the past on the issue were worried the rules might incur revenue losses.

"We've just begun to review the rule, but on first glance the MMS proposal appears to be a careful adjustment of the oil valuation regulations issued in 2000 and appears to reflect many of the suggestions discussed by the MMS and the public at public workshops held last year," said a spokesperson for the American Petroleum Institute. "We appreciate the agency's effort to make the rules more clear and certain. While the overall changes are an improvement, we are disappointed that our recommendation to change the allowed rate of return on undepreciated capital investment was rejected."

Producers had wanted MMS to consider assigning a larger multiplier of 1.5 times the S&P designated bond rate for its cost of capital when considering royalty exposure.

Rep. Carolyn Maloney (D-NY), who sits on the House Government Reform Committee, disagreed with industry and MMS over the possible revenue losses associated with the new rule. "Today, [MMS] finalized an oil valuation rule that will lose money for American taxpayers. By increasing the number of deductions, this rule fails to provide for the fair return on federal resources that MMS contends it will.

"Instead, the oil companies' profits will increase while the federal government, states, and tribes will see the royalties owed to them decrease. I do not believe that [US President George W.] Bush's administration provided Congress with sufficient evidence to justify this rule change, and I'm very disappointed that it has decided to devalue the resources obtained on lands owned by the American people."