The Office of Natural Resources Revenue of the Department of the Interior recently issued a proposed rule to change the valuation process for the payment of royalties for oil and gas produced from Federal onshore and offshore leases and coal produced from Federal and Indian leases. The stated purpose of the proposed rule is to provide greater simplicity, certainty, clarity and consistency in the valuation process and to decrease the costs of regulatory compliance. See 80 Fed. Reg. 608 (January 6, 2015), available here.

Establishment of Discretionary Default Royalty Values and Allowances

The proposed rule would establish a "default provision" that would allow the Office of Natural Resources Revenue (ONRR) to "exercise considerable discretion" to establish a royalty valuation when "(1) a contract does not reflect total consideration, (2) the gross proceeds accruing under a contract do not reflect reasonable consideration due to misconduct or breach of the duty to market, or (3) it cannot ascertain the correct value of production because of a variety of factors, including but not limited to, a lessee's failure to provide documents." 80 Fed. Reg. 609-610. Additional changes would allow ONRR to establish the values of a lessee's transportation, processing and coal washing allowances.

In determining a default royalty value, ONRR would use several discretionary factors including:

• The value of like-quality oil, gas and coal from nearby leases, plants or mines;
• Public sources of market information;
• Information reported to ONRR on various reporting forms; and
• "Any information ONRR deems relevant" regarding the lease.

The Elimination of Benchmarks for Gas and Coal Royalty Valuations

The proposed rule also would eliminate the valuation benchmarks currently used to value gas royalties for non-arm's-length sales from Federal oil and gas leases. Instead of benchmarks, the proposed rule would value these royalties based on gross proceeds from the first arm's-length resales ("affiliate resales"), index prices, or weighted average pool prices. ONRR similarly proposes to eliminate the use of benchmarks to value royalties for non-arm's-length sales from Federal and Indian coal leases, and to base these royalties on affiliate resales. ONRR also proposes to "value sales of coal between cooperative members using the first arm's-length sale or a netback methodology."

Possible Impact on Collections and Administrative Appeals

By providing greater discretion in determining royalty values, the proposed rule would enable ONRR to seek higher royalty payments from Federal and Indian mineral lessees. In moving away from established bright lines for determining product valuations, the proposed rule will likely result in greater opportunities for administrative appeals challenging ONRR’s reliance on and interpretation of resales, index prices and weighted average pool price as well as other alternative methodologies.

Comments pertaining to the proposed rule must be submitted to ONRR on or before March 9, 2015.