A federal court has rejected an appeal by the American Petroleum Institute (API) of a 2016 rule that steepened royalty payments for natural gas and oil produced on federal property.
The role of natural gas index pricing in determining those royalty obligations featured prominently in the complaint, which the oil and gas trade group filed in the U.S. Court of Appeals for the Tenth Circuit.
At issue is a 2016 modification by the Department of the Interior’s (DOI) Office of Natural Resources Revenue (ONRR) to the royalty valuation regulations for federal oil and gas leases.
Prior to the rule change, ONRR allowed producers selling gas to their own affiliates to value that gas using a multifactor benchmark standard. Following the rule change, producers may use index pricing from approved trade publications such as NGI to value that gas, but it must be based on the highest reported monthly bidweek price among locations to which the gas could potentially be transported – regardless of any constraints for that production month.
API argued that ONRR did not justify the requirement to use the high-end value rather than the average or median bidweek price, an argument that the Tenth Circuit judges did not buy.
The court instead sided with ONRR’s reasoning that using the highest possible bidweek price simplifies the royalty calculation process. ONRR also has made no secret of its mandate to maximize royalty collection, the judges noted.
As for oil and gas sold to non-affiliated third parties, aka “arm’s length” transactions, API challenged the rule’s impact on the gross-proceeds evaluation method of royalty obligations.
Prior to the 2016 rule, producers could deduct costs associated with deepwater oil and gas gathering from their royalty payments. API argued that rescinding this provision was unfair to deepwater lessees who had made multibillion-dollar investment decisions on the understanding that gathering costs could be subtracted from royalty obligations.
The Tenth Circuit rejected this argument as well, saying that ONRR acted within its rights to rescind the deepwater policy.
API also unsuccessfully challenged a provision of the rule relating to caps placed on transportation and processing allowances that federal lessees may deduct from their royalty obligations. The 2016 rule eliminated the ability for producers to claim exemptions to these caps.
Federal lands and waters supply about 24% of U.S. oil output and 11% of natural gas production, according to API.
