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CFR Citation: 30 CFR Part 206

RIN ID: RIN 1010-AD00

NOTICE: RULES

ACTION: Royalty management:

DOCUMENT ACTION: Final rule.

SUBJECT CATEGORY: Indian Oil Valuation

DATES: Effective February 1, 2008.

DOCUMENT SUMMARY: The Minerals Management Service (MMS) is amending the existing regulations regarding valuation, for royalty purposes, of oil produced from Indian leases. These amendments will clarify and update the existing regulations.

SUMMARY: Indian oil valuation,

SUPPLEMENTAL INFORMATION

The MMS published a proposed rule in the Federal Register on February 13, 2006 (71 FR 7453), referred to in this rule as the 2006 Indian Oil Proposed Rule or, simply, the proposed rule, that would amend the regulations governing the valuation for royalty purposes of crude oil produced from Indian leases. Before developing the proposed rule, MMS held a series of eight public meetings in March and June 2005 to consult with Indian tribes and individual Indian mineral owners and to obtain information from interested parties. The intent of the proposed rulemaking was to add more certainty to the valuation of oil produced from Indian lands, eliminate reliance on oil posted prices, and address the unique terms of Indian tribal and allotted leasesin particular, the major portion provision. Because of the response from Indian tribes and industry to the proposed rule, MMS plans to convene a negotiated rulemaking committee that will make recommendations regarding the major portion provision in Indian tribal and allotted leases.

For clarification, relevant rulemaking activity is listed below. Publication date Federal Register reference Publication title Referred to in this final rule as July 7, 2006.......................... 71 FR 38545................... Reporting Amendments Proposed Rule..... 2006 Reporting Amendments Proposed Rule. February 13, 2006..................... 71 FR 7453.................... Indian Oil Valuation Proposed Rule..... 2006 Indian Oil Proposed Rule. March 10, 2005........................ 70 FR 11869................... Federal Gas Valuation Final Rule....... 2005 Federal Gas Final Rule. Public Workshop on Proposed Rule Establishing Oil Value for Royalty Due on Indian Leases. February 22, 2005..................... 70 FR 8556.................... (Proposed Rule of February 12, 1998 (63 2005 Establishing Oil Value for Royalty FR 7089) and Supplementary Proposed Due on Indian LeasesWorkshop. Rule of January 5, 2000 (65 FR 403 are withdrawn). May 24, 2004 Effective August 1, 2004. 69 FR 29432................... Federal Oil Valuation.................. 2004 Federal Oil Final Rule Technical Final Rule Technical Amendment......... Amendment. May 5, 2004 Effective August 1, 2004.. 69 FR 24959................... Federal Oil Valuation.................. 2004 Federal Oil Final Rule. Final Rule............................. September 28, 2000.................... 65 FR 58237................... Establishing Oil Value for Royalty Due 2000 Indian Oil Proposed Rule. on Indian Leases: Proposed Rule. March 15, 2000 Effective June 1, 2000 65 FR 14022................... Establishing Oil Value for Royalty Due 2000 Federal Oil Final Rule. Amended 2004. on Federal Leases: Final Rule. February 28, 2000..................... 65 FR 10436................... Establishing Oil Value for Royalty Due 2000 Indian Oil Revised Supplementary on Indian Leases. Proposed Rule. Supplementary Proposed Rule and Notice of Extension of Comment Period. January 5, 2000....................... 65 FR 403..................... Establishing Oil Value for Royalty Due 2000 Indian Oil Supplementary Proposed on Indian Leases. Rule. Supplementary Proposed Rule............ August 10, 1999: Effective January 1, 64 FR 43506................... Amendments to Gas Valuation Regulations 1999 Indian Gas Final Rule. 2000. for Indian Leases. Final Rule............................. April 9, 1998......................... 63 FR 17349................... Establishing Oil Value for Royalty Due 1998 Indian Oil Proposed Rule Comment on Indian Leases: Proposed Rule. Period Extension. Extension of Public Comment Period..... February 12, 1998..................... 63 FR 7089.................... Establishing Oil Value for Royalty Due 1998 Indian Oil Proposed Rule. on Indian Leases. Proposed Rule.......................... January 15, 1988...................... 53 FR 1184.................... Part 3Revision of Oil Product 1988 Oil Valuation Final Rule. Valuation Regulations and Related Topics. Final Rule............................. [[Page 71232]]

II. Comments on the Proposed Rule

The MMS received comments from the following entities: Two Indian tribes, three industry trade associations, eight oil and gas producers, and one individual. The comments were generally not supportive of the changes outlined in the 2006 Indian Oil Proposed Rule. The most controversial topics were the proposed modification of Form MMS2014, Report of Sales and Royalty Remittance, as part of the proposed major portion calculations, and the proposed transportation allowance changes.

A. Definitions

The following chart summarizes the changes to definitions adopted in this final rule. The comments addressing the specific issues are summarized in the discussion that follows the chart.
Changes to Definitions at 30 CFR 206.51 Change proposed in 2006 Indian Definition Oil Proposed Rule This final rule Affiliate...................... Add new definition.............. Adds new definition as proposed. Area........................... Revise definition............... Not adopted as proposed. Arm'slength contract.......... Revise definition............... Adopts as proposed. Designated area................ Add new definition.............. Not adopted as proposed. Exchange agreement............. Add new definition.............. Adds new definition as proposed. Gross proceeds................. Revise definition............... Revises as proposed. Indian tribe................... Revise definition............... Revises as proposed. Individual Indian mineral owner Add new definition.............. Adds new definition as proposed. Lessee......................... Revise definition............... Revises proposed definition. Lessor......................... Add new definition.............. Adds new definition as proposed. Likequality lease products.... Eliminate....................... Eliminates as proposed. Likequality oil............... Replace and modify existing Adds new definition as proposed. definition of LikeQuality Lease Products.
Load oil....................... Eliminate....................... Eliminates as proposed. Location differential.......... Add new definition.............. Adds new definition as proposed. Marketable condition........... Revise definition............... Revises proposed definition in light of comments. Marketing affiliate............ Eliminate....................... Eliminates as proposed. Minimum royalty................ Eliminate....................... Eliminates as proposed. Net profit share............... Eliminate....................... Eliminates as proposed. Netback method................ Eliminate....................... Eliminates as proposed. Oil............................ Revise definition............... Revises as proposed. Oil shale...................... Eliminate....................... Eliminates as proposed. Oil type....................... Add new definition.............. Not adopted as proposed. Operating rights owner......... Add new definition.............. Adds new definition as proposed. Posted price................... Eliminate....................... Eliminates as proposed. Quality differential........... Add new definition.............. Adds new definition as proposed. Selling arrangement............ Eliminate....................... Not eliminated as proposed. Tar sands...................... Eliminate....................... Eliminates as proposed.

In the 2006 Indian Oil Proposed Rule, MMS proposed to add a definition of the term affiliate and revise the definition of arm's length contract in Sec. 206.51 to conform to the 2004 Federal Oil Final Rule and to align the rule with the court's decision in National Mining Association v. Department of the Interior, 177 F.3d 1 (DC Cir. 1999).

Comment: The MMS received one comment regarding the proposed change to the definition of affiliate. The industry association commenter stated that ``[o]pposing economic interest is not a defined term, and MMS does not state any factors that will be considered in determining whether parties to a contract have opposing economic interest. MMS should define the term `opposing economic interests' and incorporate determining factors from the Vastar decision in the definition.''

MMS Response: The MMS examines whether two parties have opposing economic interests on a casebycase basis under existing precedents. We have included the undefined phrase ``opposing economic interest'' in our definition of ``arm'slength contract'' since the oil royalty valuation rules were first issued in 1988.

The definition of ``arm'slength contract'' as originally proposed in 1987 did not include the requirement for ``opposing economic interests.'' Our 1987 proposal defined ``arm'slength contract'' simply to include ``a contract or agreement between independent, nonaffiliated persons.'' 52 FR 1858 (January 15, 1987). However, at the urging of a state commenter, MMS included the ``opposing economic interest'' concept in the final rule in 1988. The state commenter stressed that even though the inclusion of additional criteria such as ``adverse economic interest'' would increase subjectivity, ``the appeals process is in place to provide protection against arbitrary decisions.''

The 1988 rule established the basic principles of MMS royalty valuation that have not changed over time. See Revision of Oil Product Valuation Regulations and Related Topics, 53 FR 1184 (Jan. 15, 1988) (``Although the parties may have common interests elsewhere, their interests must be opposing with respect to the contract in issue. The general presumption is that persons buying or selling products from Federal and Indian leases are willing, knowledgeable, and not obligated to buy or sell.'') We affirm those principles today.

As was predicted by the commenter in 1988, the appeals process has not only provided protection against arbitrary decisions, but it has also resulted in administrative precedent interpreting the phrase ``opposing economic interest.'' For example, through appeals such as Vastar Resources, Inc., 167 IBLA 17 (2005), the Department of the Interior has determined that ``opposing economic interests'' need not be absolute in order to meet the definition of an ``arm'slength contract.'' Accordingly, MMS will focus on the parties' economic interests in the specific contract at issue,
[[Page 71233]]
and the fact that the parties may have common interests elsewhere does not necessarily negate their ability to have opposing economic interests with respect to the contract under view. Further, opposing economic interests are rarely absolute even within a single contract. For example, between two parties to an oil and gas lease, some economic interests are common and some are opposed. When oil is taken in kind, the common economic interest of production may appear to outweigh the remaining opposing economic interests. In Vastar, the Interior Board of Land Appeals considered objective factors such as the contentious negotiations leading to the execution of the contract, the terms of the contract, and the parties' subsequent conduct as evidence of the parties' opposing economic interests regarding the particular sales contract.

For purposes of interpreting the definition of ``opposing economic interests,'' MMS will follow the decisions of the Interior Board of Land Appeals until further rulemaking prescribes otherwise.

This final rule adopts the proposed definitions of affiliate and arm'slength contract. The MMS believes the existing definitions at Sec. 206.51, should be amended to be consistent with the DC Circuit's decision in National Mining Association v. Department of the Interior, 177 F.3d 1 (DC Cir. 1999). The new definition of affiliate and the clarification to the definition of arm'slength contract will also make the definitions consistent with the 2004 Federal Oil Final Rule.

As we explained in amending the definition of ``affiliate'' in the Federal crude oil valuation rule promulgated on March 15, 2000 (effective June 1, 2000):

In National Mining Association v. Department of the Interior, 177 F.3d 1 (DC Cir. 1999) (decided May 28, 1999), the United States Court of Appeals for the District of Columbia Circuit addressed the Office of Surface Mining Reclamation and Enforcement's (OSM's) so called ``ownership and control'' rule at 30 CFR 773.5(b). That rule presumed ownership or control under six identified circumstances. One of those circumstances was where one entity owned between 10 and 50 percent of another entity. The court found that OSM had not offered any basis to support the rule's presumption ``that an owner of as little as ten per cent of a company's stock controls it.'' 177 F.3d at 5. The court continued, ``While ten percent ownership may, under specific circumstances, confer control, OSM has cited no authority for the proposition that it is ordinarily likely to do so.'' Id. * * *

In the final rule, MMS is revising the definition of ``affiliate'' in light of the National Mining Association decision. In the event of ownership or common ownership of between 10 and 50 percent, paragraph (2) of the definition in the final rule, instead of creating a presumption of control, identifies a number of factors that MMS will consider in determining whether there is control under the circumstances of a particular case.

65 FR 14022, 14039 (Mar. 15, 2000). We adopt the same amendment here for Indian leases. Thus, the final rule replaces the presumption of control (and the consequent presumption of a nonarm'slength relationship) in the current rule, in the event of ownership or common ownership of 10 through 50 percent of the voting stock, with a caseby case examination of the circumstances.

We emphasize that MMS will not presume control in the event of ownership or common ownership of 10 through 50 percent. MMS anticipates that in considering the factors identified in paragraph (2) of the definition, the facts of a particular case would demonstrate control (and therefore affiliation) only in exceptional circumstances. MMS anticipates that the facts will show that the relationship between corporate entities with minority ownership or common ownership is an arm'slength relationship in the vast majority of cases. MMS presumes in the absence of other evidence that transactions between corporate entities with minority ownership or common ownership are undertaken in good faith. The applicable rule is generally expressed in State Public Utilities Commission ex rel. Springfield v. Springfield Gas and Electric Company, 291 Ill. 209, 234.

Whether a contract or arrangement between the lessee and its purchaser should be regarded as arm's length or nonarm's length does not depend on whether the lease is a Federal lease or an Indian lease.

The MMS proposed to change the definition of area as part of the proposed major portion value calculation changes. This final rule does not include the proposed change to the definition of area. That term is still used in the major portion valuation provisions, which remain unchanged in this final rule for the reasons explained below. Therefore, the definition of area at Sec. 206.51 is retained.

This final rule does not include the proposed definition of designated area because, as explained below, this final rule does not adopt the proposed major portion valuation provisions.

This final rule adopts the proposed definition of exchange agreement, which is used in the new valuation provisions at Sec. 206.52(e).

This final rule includes the proposed changes to the definition of gross proceeds. This change is consistent with the 2004 Federal Oil Final Rule and makes helpful technical clarifications. There were no comments on this proposed change.

This final rule adopts the proposed definitions of Indian tribe and individual Indian mineral owner. The new wording clarifies that this rule applies to Indian tribes for whom the U.S. holds a mineral in trust or to individual Indians who hold title to a mineral subject to a restriction against alienation. This is more specific than the former reference to lands held in trust or subject to a restriction against alienation.

This final rule adopts the proposed definitions of lessee and operating rights owner, except that the final rule does not adopt clause (3) of the proposed definition of ``lessee.'' With one exception, the changes in wording that are adopted are technical corrections and clarifications.

As the Court noted in Fina Oil and Chemical Corp. v. Norton, 332 F.3d 672 (DC Cir. 2003), regarding gross proceeds and the definition of ``lessee,'' the term ``lessee'' was defined by Federal statute as ``any person to whom the United States, an Indian tribe, or an Indian allottee issues a lease, or any person who has been assigned an obligation to make royalty or other payments required by the lease.'' Public Law No. 97451 Sec. 3(7), 96 Stat. 2447, 2449 (amended in 1996 to read ``any person to whom the United States issues an oil and gas lease or any person to whom operating rights in a lease have been assigned''), codified at 30 U.S.C. 1702(7). The 1988 regulations followed this statutory definition. In the Fina case, the court found that MMS improperly sought to use a whollyowned subsidiary's arm's length resale proceeds as the measure of the lessee's gross proceeds in conflict with the regulation's plain language. (Under the 1988 valuation rules, the affiliate's resale proceeds were used as value only if the affiliate was a ``marketing affiliate,'' defined as an affiliate of the lessee whose function was to acquire only the lessee's production and market that production. The royalty value of oil transferred nonarm's length to the marketing affiliate was the affiliate's gross proceeds, provided the marketing affiliate sold the oil at arm's length.) The Fina court suggested that if MMS believes that basing value on the intracorporate transfer is too favorable to producers, it should amend the regulations through noticeandcomment rulemaking, not under the
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guise of interpretation. MMS is doing so in this final rule in the revised 30 CFR 206.52(a).

In this respect, this rule is making the same change made in the Federal crude oil valuation rule in 2004 at 30 CFR 206.102(a). In many respects, this final Indian oil valuation rule follows the same organization and structure as the Federal oil valuation rule promulgated on March 15, 2000, as amended May 5, 2004. The final Federal oil valuation rule adopted in March 2000 did not distinguish between ``marketing affiliates,'' as defined in 1998, and other affiliates, because MMS adopted an altogether new valuation approach. That is, the value of oil produced from a Federal lease and transferred to any affiliate is now determined by the affiliate's ultimate disposition of that oil or, at the lessee's option under certain conditions, at an indexbased value or other applicable measure. The definition of ``marketing affiliate'' therefore was removed from the Federal oil valuation rule.

In the Indian lease context, MMS did not propose, and this final rule does not include, an indexbased valuation option because for the vast majority of Indian leases, it is either impractical or impossible to derive reliable adjustments for location and quality between the lease and a market center with reliable published index prices. Further, in view of the lower volumes and number of transactions involved for most Indian leases, such an option would serve little purpose. As explained elsewhere in this preamble, the final rule simply adopts the proposal to replace the ``benchmarks'' originally promulgated in 1988, which have proven to be difficult to apply in practice, with the first arm'slength sale (minus any transportation costs) as the basis of value in the event of a nonarm'slength transfer by the lessee, and where the oil is sold at arm'slength before refininga rare circumstance in the context of Indian leases that produce crude oil.

Since the general valuation approach adopted today eliminates the ``marketing affiliate'' distinction by focusing on the first arm's length sale, it is appropriate that the definition of ``marketing affiliate'' be removed from these regulations. However, it does not follow that the definition of ``lessee'' needs to be amended. Moreover, MMS has written this rule in plain English format, using the term ``you'' to mean a lessee, operator, or other person who pays royalties under this subpart. In all, particularly in light of the removal of the definition of ``marketing affiliate,'' MMS is adopting the definition of ``lessee'' as proposed without proposed clause (3) incorporating affiliates. As the term ``lessee'' is used throughout the final rule, it either refers to the royalty payor or is specifically distinguished from the term ``affiliate.'' This change continues to support the general valuation approach adopted today and is consistent with statutory interpretation principles set out in United States v. Bestfoods, 524 U.S. 51, 61 (1998).

Currently, there is no definition of the term lessor in any of the Indian valuation regulations. Because this term is used in numerous places in the regulations, MMS proposed to add a definition in the 2006 Indian Oil Proposed Rule. This final rule adopts the proposed definition of lessor.

This final rule does not include the proposed definition of oil type because the final rule does not adopt the proposed major portion provisions. As explained further below, MMS plans to refer the major portion issue to a negotiated rulemaking committee. In this final rule, the term likequality lease products will be changed to likequality oil, and the reference to similar legal characteristics in the current definition of likequality lease products will be deleted. The term likequality lease products is not used in the regulations governing Indian oil valuation at Sec. Sec. 206.50 through 206.55. The definition at Sec. 206.51 is identical to the definitions in the 2005 Federal Gas Final Rule and 1999 Indian Gas Final Rule (see Sec. Sec. 206.151 and 206.171). The existing regulations at Sec. 206.51 and the changes made in this final rule, however, refer to likequality oil; and this final rule therefore will define that term. The existing definition refers to ``similar chemical, physical, and legal characteristics.'' Crude oil has not been pricecontrolled in the last 25 years, and there are no legal classifications of crude oil that have any bearing on royalty valuation issues. We therefore have deleted the reference to similar legal characteristics.

This final rule includes the proposed definitions of location differential and quality differential because those terms are used in the provisions governing valuation of oil disposed of under arm's length exchange agreements.

In the 2006 Indian Oil Proposed Rule, MMS proposed to change the definition of the term marketable condition in Sec. 206.51 to mean lease products
that are sufficiently free from impurities and otherwise in a condition that they will be accepted by a purchaser under a sales contract or transportation contract typical for disposition of production from the field or area.

The current definition refers to lease products
that are sufficiently free from impurities and otherwise in a condition that they will be accepted by a purchaser under a sales contract typical for the field or area.

Summary of Comments: Three industry associations commented on this proposed change. With respect to the proposed change in the definition of marketable condition to add a reference to transportation contracts, one industry association said:

We do accept that MMS has the authority to require the lessee to put the oil in the condition that contracts for the sale and purchase of oil typical in a field or area require, or to pay MMS on the value that oil in such condition would realize. * * *

We believe it is clear that it would not be reasonable for a producer of sour oil on the outer continental shelf to be required to sweeten oil simply because the pipeline in the area happens to be unwilling to transport any sour oil. Similarly, if oil is of a viscosity that allows it to be transported by truck, but which is too viscous to be transported by the local pipeline without blending, blending is not needed to put the oil in marketable condition. The oil is marketable in exactly the form it is in. It is acceptable to the party who will ultimately use it. * * *
* * * * *
[W]e strongly disagree with the proposal to require a lessee to meet the requirements of transportation contracts at no cost to the lessor. MMS has given no reasons for this proposed change and we believe that it is clear that the requirements of transportation contracts are different in kind from the requirements of sales contracts and that such costs are costs associated with

transportation and should be deductible.

Another industry association opposes the proposed change to the definition of marketable condition because, in the association's view, it arbitrarily classifies certain deductible transportation costs as nondeductible costs of placing production in marketable condition. The third commenting industry association stated that it did not understand the proposed change.

MMS Response: The marketable condition rule has always required lessees to remove basic sediment and water to the level required for the relevant pipeline. There appears to be no controversy in this respect. It is not our intention to require a lessee to sweeten sour oil at its own expense simply because a particular pipeline does not accept sour oil and the marketable condition rule has never been interpreted to impose such a requirement.

MMS is not adopting the proposed change to the definition of ``marketable condition'' in this final rule because it
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is not necessary to do so, particularly in the context of crude oil production and sales. MMS will continue to use the existing definition, which is the same as the definition used in the Federal oil valuation rule. MMS continues to follow the marketable condition principle set out in United States v. General Petroleum Corp. of California, 73 F.Supp. 225, aff'd, Continental Oil Co. v. United States, 184 F.2d 802 (9th Cir. 1950).

This final rule eliminates the definitions of the terms load oil, minimum royalty, net profit share, oil shale, and tar sands because none of those terms is used either in the existing regulations governing Indian oil valuation at Sec. Sec. 206.51 through 206.55 or in this final rule. This final rule also deletes the last sentence of the existing definition of oil, because neither the existing Sec. 206.51 definition nor this final rule refers to or uses the term tar sands.

This final rule also eliminates the definitions of marketing affiliate, netback method, and posted price because the regulations no longer contain those terms.

This final rule retains the definition of selling arrangement in the existing Sec. 206.51, which the 2006 Indian Oil Proposed Rule would have eliminated, because the transportation allowance provisions of the existing regulations at Sec. 206.55 are not changed in this final rule, as explained below. Those provisions use the term selling arrangement. The MMS recognizes that payors no longer report royalties or allowances by selling arrangement. The MMS published the 2006 Reporting Amendments Proposed Rule that would amend the transportation allowance rules and eliminate that term. However, a final rule has not been published. Therefore, MMS has not eliminated the term selling arrangement in this final rule.

B. General Valuation Approach

The 2006 Indian Oil Proposed Rule first analyzed where oil is produced from Indian leases and how it is marketed. Among other things, the discussion in the preamble to the 2006 Indian Oil Proposed Rule noted that the overwhelming majority of crude oil produced from Indian leases is reported as being sold at arm's length at the lease. There are relatively few nonarm'slength dispositions of oil reported and only one situation in which the lessee or its affiliate refines oil produced from the lessee's leases. In all other instances, it appears that oil is sold at arm's length at some point before it is refined. There are also very few instances in which lessees are reporting transportation allowances. At the present time, only two lessees of Indian leases are reporting transportation allowances for crude oil. One of those involves a nonarm'slength transportation arrangement. Currently, one of the major producing tribes takes more than 90 percent of its royalty oil inkind.

In addition, Indian tribal and allotted leases are distributed geographically much differently than Federal leases, and oil produced from Indian leases is marketed much differently than oil produced from Federal leases. Except for the possibility of some oil sold in Oklahoma, which accounts for only about 10 percent of the oil sold from Indian leases, oil produced from Indian leases apparently does not flow to, and is not exchanged to, Cushing, Oklahoma, where New York Mercantile Exchange (NYMEX) prices are published. Thus, with the exception of Oklahoma and possibly one type of oil produced in Wyoming, it is extremely difficult to obtain reliable location and quality differentials between Cushing and areas where the large majority of the oil is produced from Indian leases, including the San Juan Basin, northeastern Utah, Wyoming (for other oil types), and Montana. Even in Oklahoma, almost all the oil sold from Indian leases is reported to MMS as sold at arm's length.

In light of these facts, and in contrast to the earlier 1998 Indian Oil Proposed Rule Comment Period Extension and the 2000 Indian Oil Supplementary Proposed Rule, in the 2006 Indian Oil Proposed Rule, MMS proposed not to use either NYMEX or spot market index pricing as primary measures of value for oil produced from Indian leases. Because of the environment in which Indian oil is produced and marketed, MMS proposed in the 2006 Indian Oil Proposed Rule to value oil at the gross proceeds the lessee or its affiliate receives in an arm'slength sale. In the event a lessee first transfers its oil to an affiliate and the oil is sold at arm's length before being refined, MMS proposed to use the arm'slength sale by the affiliate as the basis for royalty valuation. In addition to the fact that the first arm'slength sale is the best measure of the value of the oil, the proposed approach also would resolve the issue created by the DC Circuit's interpretation of the gross proceeds rule and the term lessee in the Federal gas royalty valuation rules in Fina Oil and Chemical Corp. v. Norton, supra.

In the rare situations in which the sale occurs away from the lease, the 2006 Indian Oil Proposed Rule provided for transportation allowances. The MMS also proposed to specify that if a lessee sells oil produced from a lease under multiple arm'slength contracts instead of just one contract, the value of the oil would be the volumeweighted average of the total consideration for all contracts for the sale of oil produced from that lease.

Further, in the event that the lessee or its affiliate enters into one or more arm'slength exchanges, and, if the lessee or its affiliate ultimately sells the oil received in exchange, the value would be the gross proceeds for the oil received in exchange, adjusted for location and quality differentials derived from the exchange agreement(s). If the lessee exchanges oil produced from Indian leases to Cushing, Oklahoma, value would be the NYMEX price, adjusted for location and quality differentials derived from the exchange agreements. If the lessee does not ultimately sell the oil received in exchange and does not exchange oil to Cushing, the lessee must ask MMS to establish a value based on relevant matters.

Finally, if the lessee transports the oil produced from the lease to its own or its affiliate's refinery, the 2006 Indian Oil Proposed Rule would require the lessee to value the oil at the volumeweighted average of the gross proceeds paid or received by the lessee or its affiliate, including the refining affiliate, for purchases and sales under arm'slength contracts of other likequality oil produced from the same field (or the same area if the lessee does not have sufficient arm'slength purchases and sales from the field) during the production month, adjusted for transportation costs. If the lessee purchases oil away from the field(s) and if it cannot calculate a price in the field(s) because it cannot determine the seller's cost of
transportation, it would not include those purchases in the weighted average price calculation.

Comment: The principal comment received regarding the general valuation approach described above was from an Indian tribe. The tribe would prefer that MMS adopt the 2000 Indian Oil Supplementary Proposed Rule that MMS withdrew in February 2005 in the 2005 Establishing Oil Value for Royalty Due on Indian LeasesWorkshop Federal Register notice. Failing that, the tribe would prefer that MMS continue to value its oil under the existing regulations at Sec. Sec. 206.50 through 206.55. The tribe's comments focus on the unreliability of posted prices and the consequent prior proposals to look to NYMEX or spot market index values. The tribe argued that ``MMS does not describe the `environment' that it
[[Page 71236]]
believes justifies continuing its gross proceeds/posted prices methodology. It provides absolutely no findings of how the environment has changed from the year 2000 to the present year, and how this change justifies its policy reversal.'' The tribe further asks, ``Why does MMS cite a high percentage of arm'slength transactions as a justification for never using market pricing benchmarks?'' None of the industry commenters expressed any objection to using the gross proceeds derived from the affiliate's arm'slength resale as the measure of value if the lessee first transfers oil to an affiliate.

MMS Response: The MMS agrees that posted prices are not a reliable measure of value in the current market environment. Contrary to these comments, the 2006 Indian Oil Proposed Rule does not rely on posted prices. Whether a sales price happens to be established with reference to a posted price in any particular case is irrelevant if the contract was negotiated at arm's length. The 2006 Indian Oil Proposed Rule would not establish value with reference to posted prices independent of actual gross proceeds. The tribe appears to object to using arm's length gross proceeds if the price set in an arm'slength contract happens to refer to or be based on a posted price. However, it does not explain why the negotiated arm'slength gross proceeds derived by a lessee or its affiliate is an improper or insufficient measure of value.

Further, the tribe's apparent preference for use of NYMEX or spot market index prices overlooks the fact that oil produced from Indian leases in the San Juan Basin is not generally transported or exchanged to Cushing, Oklahoma, or to another market center with an established spot market price. The tribe's comments thus overlook the consequent difficulty in determining reliable location and quality differentials that would be essential in using NYMEX or spot market index prices as a basis for valuation.

Comment: With respect to oil that is exchanged for other oil under exchange agreements, the tribe commented:

Under the law [i.e., the 1988 rules], the Nation's royalty is to be a share of the gross proceeds from the sale of oil from Navajo leases. In the 1988 Rule, MMS determined that the value of tribal oil for royalty purposes could reasonably be calculated using a company's actual gross proceeds based on posted prices. * * * Instead the companies entered into elaborate transfer and exchange agreements with affiliates, which allowed the companies to sell oil produced from Navajo leases for prices that were significantly higher than a company's posted price * * * the Nation's royalty share did not reflect the premium prices the companies received for Navajo oil.

The tribe further comments:

Simply put, MMS has forgotten why it sought to amend its valuation policies beginning with its draft rule in 1997. And those reasons are as valid today as they were in 1997: To eliminate the practices of the oil and gas industry to undervalue production through artificially posted prices for oil at the wellhead, when oil is actually exchanged/ transferred and/or valued at other locations to the benefit of oil companies.

MMS Response: The 2006 Indian Oil Proposed Rule addresses the commenter's concern regarding exchange agreements. Under the proposed rule, any ``premium'' realized through an arm'slength exchange would be captured in the royalty value because value would be based on the gross proceeds derived from an arm'slength sale of the oil received in exchange (unless the oil is exchanged to Cushing, Oklahoma). If oil is first exchanged not at arm's length, i.e., with an affiliate, the proposed rule would require valuing the oil on the basis of the affiliate's arm'slength resale price in any event.

Comment: One industry association said that it ``supports the use of comparable purchases and sales from the same field or area in the situation where the lessee refines its own oil, and the exclusion of offlease purchases that cannot be normalized.''

MMS Response: No commenter expressed objections to using the volumeweighted average of the gross proceeds paid or received by the lessee or its affiliate, including the refining affiliate, for purchases and sales under arm'slength contracts of other likequality oil produced from the same field or area, adjusted for transportation costs, if the lessee or the lessee's affiliate refines the lessee's oil.

This final rule therefore adopts the 2006 Indian Oil Proposed Rule approach to replace the ``benchmarks'' currently outlined at Sec. 206.52(c) for valuing oil not sold at arm's length. If such oil is sold before being refined, value will be based on the affiliate's arm's length resale price. If the lessee or its affiliate refines the oil without an arm'slength sale, value will be based on the volume weighted average of the gross proceeds paid or received for arm's length purchases and sales of other likequality oil produced from the same field or area.

Further, by adopting the proposed provisions for valuing production disposed of through arm'slength exchange agreements, this final rule ensures that any ``premium'' realized in the sale of oil received in exchange will be included in the royalty value. This final rule therefore addresses the tribe's comment that MMS should ``close a loophole that allows the oil companies to circumvent congressional intent and MMS's rules.''

C. Major Portion Valuation

The 2006 Indian Oil Proposed Rule would have made a number of changes to the major portion valuation provisions of the rule. The proposed rule would have used values reported on Form MMS2014 for arm'slength sales (and affiliate's arm'slength resales) of Indian oil, and values reported for oil taken in kind, produced from a designated area that MMS would identify. Values reported for oil that is refined without being sold at arm's length would not have been included in the calculation. The proposed rule would not have changed the percentile at which the major portion value is determined, i.e., the 50th percentile by volume plus one barrel of oil.

Under the 2006 Indian Oil Proposed Rule, to normalize reported values for each oil type produced from the designated area to a common quality basis, MMS would have adjusted for API gravity using applicable posted price gravity adjustment tables. The MMS would have calculated separate major portion values for different oil types because the lease provision expressly refers to ``likequality'' oil. The MMS would have designated oil types that are produced from each designated area.

To obtain the information necessary to make these calculations and adjustments, the 2006 Indian Oil Proposed Rule would have required the royalty payors to report API gravity and oil type on Form MMS2014. The MMS then would have arrayed the normalized and adjusted (for transportation costs) values in order from the highest to the lowest, together with the corresponding volumes reported at those values. The major portion value would be the normalized and adjusted price in the array that corresponds to the 50th percentile by volume plus one barrel of oil, starting from the bottom.

Under the 2006 Indian Oil Proposed Rule, lessees initially would have reported on Form MMS2014 the value of production at the value determined under the other provisions of the rule and would pay royalty on that value. The MMS then would have calculated the major portion values and notified lessees of the major portion values by publishing a notice in the Federal Register and making them available on the MMS Web site, together with the normalized gravity and the adjustment [[Page 71237]]
tables. The lessee then would have compared the major portion value to the value initially reported on Form MMS2014, normalized and adjusted for gravity and transportation. If the major portion value were higher than the value initially reported, normalized and adjusted for gravity and transportation, the lessee would have had to submit an amended Form MMS2014, reporting the value as the major portion value, and pay any additional royalty owed.

Comments: The majority of the comments MMS received on the 2006 Indian Oil Proposed Rule addressed the major portion issue. Both of the Indian tribal commenters and all the industry commenters opposed the proposed changes, but for different reasons.

In general, the tribal commenters believed that the percentile at which the major portion should be measured should be consistent with the Indian gas royalty valuation provisions (i.e., the 25th percentile starting from the top of the array, rather than the 50th percentile plus one unit of production starting from the bottom of the array). The tribal commenters also argued that the major portion calculation should not be limited to Indian leases in a ``designated area.'' One tribal commenter argued that MMS should retain the existing reference to a ``field,'' and include all Indian, Federal, state, and private leases that may be within the field. The other tribal commenter argued that the calculation either should be expanded to include at least Federal leases outside the designated area or that the designated area should be expanded to include Federal leases in the area. The tribal commenters supported the concept of normalizing oil prices to a uniform quality before calculating the major portion value.

Industry commenters vigorously opposed the proposed requirements to report oil gravity and type. They also opposed any expansion of a designated area to include Federal leases, particularly because the requirement to report oil gravity and type would extend to those Federal leases identified as being within a designated area. The industry commenters asserted that the systems changes that these requirements would necessitate, including both programming changes and the development of different reporting systems for Federal and Indian leases, would be prohibitively expensive and out of proportion to any difference in royalty value that might result. One industry association also argued that including Federal leases in the major portion calculation would result in application to those Federal leases certain records retention requirements that now apply only to Indian leases, causing further disruptions to lessees' recordkeeping and systems operations. Industry commenters agreed with retaining the 50th percentile by volume plus one barrel of oil as the measure of what constitutes the major portion and opposed any suggestion to change that measure to a higher level.

MMS Response: There appears to be almost no issue regarding major portion valuation on which the tribal and industry commenters agree, and none of the commenters support the major portion provisions of the proposed rule. As a consequence, MMS has decided not to promulgate any amendment to the current major portion provisions at the existing Sec. 206.52(a)(2) in this final rule and to convene a negotiated rulemaking committee to consider all aspects of major portion valuation.

Because of the way the amended valuation provisions for arm's length sales and nonarm'slength dispositions are codified, paragraphs (a)(2)(i) and (ii) of the existing Sec. 206.52 are redesignated in this final rule as a new Sec. 206.54(a) and (b).

D. Transportation Allowances

The MMS made several proposals regarding transportation allowances in the 2006 Indian Oil Proposed Rule. If the transportation arrangement is at arm's length, the proposed rule would incorporate the provisions of the 2000 Federal Oil Final Rule, as amended in 2004, in calculating that allowance. That allowance is based on the actual cost paid to an unaffiliated transportation provider. For arm'slength transportation allowances, MMS also proposed to eliminate the requirement at Sec. 206.55(c)(1), to file Form MMS4110, Oil Transportation Allowance Report. Instead of Form MMS4110, the lessee would have to submit copies of its transportation contract(s) and any amendments thereto within 2 months after the lessee reported the transportation allowance on Form MMS2014. This proposed change mirrors the elimination of the requirement to file the analogous Form MMS4295 for arm'slength transportation allowances under the 1999 Indian Gas Final Rule.

For nonarm'slength transportation arrangements, the lessee would have to calculate its actual costs. Under the 2006 Indian Oil Proposed Rule, Form MMS4110 would still be required, but the requirement to submit a Form MMS4110 in advance with estimated information would be eliminated. Instead, the lessee would submit the actual cost information to support the allowance on Form MMS4110 within 3 months after the end of the 12month period to which the allowance applies. This proposal also mirrors the change made in the 1999 Indian Gas Final Rule at Sec. 206.178(b)(1)(ii).

The MMS also proposed that the nonarm'slength allowance calculation, and the costs that would be allowable and nonallowable under the nonarm'slength transportation allowance provisions, be revised to incorporate the provisions of the 2004 Federal Oil Final Rule.

The 2000 Federal Oil Final Rule provides that the lessee must base its transportation allowance in a nonarm'slength or nocontract situation, on the lessee's actual costs. These include (1) operating and maintenance expenses; (2) overhead; (3) depreciation; (4) a return on undepreciated capital investment; and (5) a return on 10 percent of total capital investment once the transportation system has been depreciated below 10 percent of total capital investment (Sec. 206.111(b)). The MMS proposed to incorporate the same cost allowance structure into the 2006 Indian Oil Proposed Rule, as discussed in more detail below.

Before June 1, 2000, the regulations for Federal oil valuation provided (as do current Indian oil valuation regulations) that, in the case of transportation facilities placed in service after March 1, 1988, actual costs could include either depreciation and a return on undepreciated capital investment or a cost equal to the initial investment in the transportation system multiplied by the allowed rate of return. The regulations before June 1, 2000, did not provide for a return on 10 percent of total capital investment once the system has been depreciated below 10 percent of total capital investment. The 2000 Federal Oil Final Rule eliminated the alternative of a cost equal to the initial investment in the transportation system multiplied by the allowed rate of return because it became unnecessary in view of the other changes made in the rule and because it had been used in very few, if any, situations.

The 2000 Federal Oil Final Rule also set forth the basis for the depreciation schedule to be used in the depreciation calculation. See Sec. 206.111(h). The MMS proposed to adopt identical provisions for this rule through incorporation, except that the relevant date would have been the effective date of a final rule that adopted those provisions.

In the 2000 Federal Oil Final Rule, the depreciation schedule for a transportation system depended on whether the lessee owned the system on, or acquired the system after, the effective date of the final rule. The MMS
[[Page 71238]]
proposed to apply the same principle in the context of Indian leases.

Finally, the 2004 Federal Oil Final Rule, which amended Sec. 206.111(i)(2), changed the allowed rate of return used in the non arm'slength actual cost calculations from the Standard & Poor's BBB bond rate to 1.3 times the BBB bond rate. In March 2005, MMS promulgated an identical change to the allowed rate of return used in the calculation of actual costs under nonarm'slength transportation arrangements in the 2005 Federal Gas Final Rule, which amended Sec. 206.157(b)(2)(v). The proposed change to this rule would incorporate this same change, for the same reasons the rate of return was changed in the 2004 Federal Oil Final Rule and 2005 Federal Gas Final Rules (i.e., 1.3 times the BBB bond rate more accurately reflects the lessees' cost of capital).

Comments: One of the two tribal commenters offered specific comments on the transportation allowance provisions of the proposed rule. The tribe expressed concern ``that the MMS would ultimately apply transportation allowance criteria established for Federal leases upon Indian leases, without due consideration for certain Indian lease provisions and policies.'' However, the tribe did not explain which cost elements it believed to be improper and did not identify any difference in relevant lease terms between Indian and Federal leases. The tribe opposes eliminating the Form MMS4110 filing requirement. The tribe ``believes that Indian lessors should and must receive prior notification of all allowance deductions from its [sic] royalty and, if MMS is correct in that transportation allowances are limited for Indian leases, then it should not be burdensome for the few royalty reporters to continue to submit Form MMS4110.'' The tribe opposes changing rate of return used in calculating actual transportation costs under non arm'slength transportation arrangements and wants MMS to retain the BBB rate in the existing rule at Sec. 206.55(v).

The other tribal commenter appears to oppose the transportation allowance provisions as part of its general opposition to the entire proposed rule.

One of the industry association commenters supports using the same transportation cost elements for Indian and Federal leases. The commenter agrees with the proposed elimination of Form MMS4110 and supports the proposed change in the rate of return used in calculating actual transportation costs to 1.3 times the BBB bond rate. However, the commenter expresses concerns about the accessibility of that rate and wants MMS to post the rate.

Another industry association commenter says that there is no reason to treat oil pipeline costs differently depending on lessor ownership. That commenter also supports changing the rate of return to 1.3 times the BBB bond rate for the same reason that the rate was changed in the 2004 Federal Oil Final Rule and 2005 Federal Gas Final Rule. This commenter further suggests (presumably referring to nonarm'slength situations) that reporting actual transportation costs in the production month in which they occur is burdensome. The commenter notes that the Royalty Reporting Subcommittee of the Royalty Policy Committee (an MMS advisory committee) developed several options for making prior period adjustments, but none of the options were adopted because the stakeholders couldn't reach consensus. This commenter also supports eliminating the requirement to prefile Form MMS4110 for nonarm's length transportation arrangements and eliminating any form filing for arm'slength transportation arrangements. The commenter also opposes having to file arm'slength transportation contracts and amendments with MMS as unnecessarily burdensome because lessees have to retain those documents and provide them on request in any event.

MMS Response: At the present, lessees are reporting only three transportation allowances on Indian leases. Two are arm'slength transportation arrangements on certain Ute tribal leases and the other is a nonarm'slength transportation arrangement for production from certain Shoshone and Arapaho leases on the Wind River Reservation.

The issues involved in the proposed amendments to the transportation allowance provisions are difficult and have generated an unusual degree of controversy relative to the very limited number of transactions to which they apply. The MMS believes that further analysis of these questions is appropriate and has decided to reserve the transportation allowance issue for a possible future supplemental final rulemaking. If MMS decides to seek further comment on the transportation allowance provisions of the proposed rule, it will publish an appropriate notice.

In view of the change to the structure of the codified sections of the rule resulting from the changes to the valuation provisions, the existing transportation allowance rules (Sec. Sec. 206.54 and 206.55 of the existing rule) are redesignated in this final rule as Sec. Sec. 206.56 and 206.57. Certain conforming amendments are also made to correct crossreferences to other sections. Otherwise, the existing rules remain unchanged.

E. Other Issues

In proposed Sec. 206.50, MMS proposed adding a provision that, if the regulations are inconsistent with a Federal statute, a settlement agreement or written agreement, or an express provision of a lease, then the statute, settlement agreement, written agreement, or lease provision would govern to the extent of the inconsistency. A ``written agreement'' would mean a written agreement between the lessee and the MMS Director, and approved by the tribal lessor for tribal leases, establishing a method to determine the value of production from any lease that MMS expects at least would approximate the value established under the regulations. The MMS received no comments opposed to this provision, and this final rule adopts it.

Regarding records retention, the proposed rule explained that proposed Sec. 206.64 is adapted from Sec. 206.105, and that the time for which records must be maintained is governed by Sec. 103(b) of the Federal Oil and Gas Royalty Management Act, 30 U.S.C. 1713(b), as originally enacted. That requirement is not affected by the change in 30 U.S.C. 1724(f), which was enacted as part of the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996 and applies only to Federal leases. The referenced regulations in proposed Sec. 206.64 reflect this difference. The MMS received no comments opposed to this provision, and this final rule adopts it.
III. Procedural Matters

1. Summary Cost and Royalty Impact Data

There will be no additional administrative costs/savings or royalty impacts as a result of this final rule. There will be no change in royalties or administrative burdens to industry, state and local governments, Indian tribes, individual Indian mineral owners, or the Federal Government.

All administrative costs/savings and royalty impacts listed in the 2006 Indian Oil Proposed Rule were the result of the proposed major portion provision, the additional information collection required by that provision, and the transportation allowance provision. The majority of the costs under the 2006 Indian Oil Proposed Rule were [[Page 71239]]
associated with the proposed major portion provision. Neither the proposed major portion provision nor the proposed transportation allowance provision is adopted under this final rule. As a result, the existing provisions at Sec. 206.50 through 206.55 will be retained. In Section II, Comments on the Proposed Rule, MMS explains plans to convene a negotiated rulemaking committee that will make
recommendations regarding the implementation of the major portion provision found in most Indian tribal and allotted leases. Also, under Section II D, Transportation Allowance, MMS is reserving the transportation allowances issues for a possible future supplemental final rulemaking.

There are no administrative costs and royalty impacts of this final rule to industry, state and local governments, Indian tribes and individual Indian mineral owners, or the Federal Government. 2. Regulatory Planning and Review, Executive Order 12866

This final rule is not a significant regulatory action. However, in view of the subject matter of the regulation, the Office of Management and Budget has reviewed this rule under Executive Order 12866.

1. This rule will not have an effect of $100 million or more on the economy. It would not adversely affect in a material way the economy, productivity, competition, jobs, the environment, public health or safety, or state, local, or tribal governments or communities.

2. This rule will not create a serious inconsistency or otherwise interfere with an action taken or planned by another agency.

3. This rule will not materially affect entitlements, grants, user fees, loan programs, or the rights and obligations of their recipients.

4. This rule does not raise novel legal or policy issues. 3. Regulatory Flexibility Act

The Department of the Interior certifies that this final rule will not have a significant economic effect on a substantial number of small entities as defined under the Regulatory Flexibility Act (5 U.S.C. 601 et seq.). An initial Regulatory Flexibility Analysis is not required. Accordingly, a Small Entity Compliance Guide is not required.

Your comments are important. The Small Business and Agricultural Regulatory Enforcement Ombudsman and 10 Regional Fairness Boards were established to receive comments from small businesses about Federal agency enforcement actions. The Ombudsman will annually evaluate the enforcement activities and rate each agency's responsiveness to small business. If you wish to comment on the enforcement actions in this rule, call 18007343247. You may comment to the Small Business Administration without fear of retaliation. Disciplinary action for retaliation by an MMS employee may include suspension or termination from employment with the Department of the Interior.
4. Small Business Regulatory Enforcement Fairness Act (SBREFA)

This final rule is not a major rule under 5 U.S.C. 804(2), the Small Business Regulatory Enforcement Fairness Act. This final rule:

1. Will not have an annual effect on the economy of $100 million or more.

2. Will not cause a major increase in costs or prices for consumers, individual industries, Federal, state, Indian, or local government agencies, or geographic regions.

3. Will not have significant adverse effects on competition, employment, investment, productivity, innovation, or the ability of United Statesbased enterprises to compete with foreignbased enterprises.

5. Unfunded Mandates Reform Act

In accordance with the Unfunded Mandates Reform Act (2 U.S.C. 1501 et seq.):

1. This final rule will not significantly or uniquely affect small governments. Therefore, a Small Government Agency Plan is not required.

2. This final rule will not produce a Federal mandate of $100 million or greater in any year; i.e., it is not a significant regulatory action under the Unfunded Mandates Reform Act. An analysis was prepared for the 2006 Indian Oil Proposed Rule; however, because certain provisions of the proposed rule were not adopted under this final rule, there are no apparent cost and royalty impacts to industry, state and local governments, Indian tribes and individual Indian mineral owners, and the Federal Government. Therefore, an analysis for this final rule was not necessary under Executive Order 12866. See Section III, Procedural Matters, Summary Cost and Royalty Impact Data. 6. Governmental Actions and Interference With Constitutionally Protected Property Rights (Takings), Executive Order 12630

In accordance with Executive Order 12630, this final rule will not have significant takings implications. A takings implication assessment is not required.

7. Federalism, Executive Order 13132

In accordance with Executive Order 13132, this final rule will not have significant federalism implications. A federalism assessment is not required. It will not substantially and directly affect the relationship between Federal and state governments. The management of Indian leases is the responsibility of the Secretary of the Interior, and all royalties collected from Indian leases are distributed to tribes and individual Indian mineral owners. This final rule will not alter that relationship.

8. Civil Justice Reform, Executive Order 12988

In accordance with Executive Order 12988, the Office of the Solicitor has determined that this final rule will not unduly burden the judicial system and meets the requirements of sections 3(a) and 3(b)(2) of the Order.

9. Paperwork Reduction Act of 1995 (PRA)

Based on comments received on the proposed rule, MMS is not revising major portion provisions in the current regulations at 30 CFR 206.50 through 206.55. We have deleted from the final rule all proposed changes to the major portion provisions. We also have revised sections in the proposed rule containing changes to transportation allowances that would have necessitated additional information collections.

During the proposed rulemaking stage, we submitted an information collection request to OMB; OMB did not approve the collection at that time. Because there are no longer any new information collection requirements in the final rule, no further

FOR FURTHER INFORMATION CONTACT Sharron L. Gebhardt, Lead Regulatory Specialist, Minerals Management Service, Minerals Revenue Management, P.O. Box 25165, MS 302B2, Denver, Colorado 80225, telephone (303) 231 3211, fax (303) 2313781, or email Sharron.Gebhardt@mms.gov. The principal authors of this final rule are John Barder of Minerals Revenue Management, MMS, Department of the Interior, and Geoffrey Heath of the Office of the Solicitor, Department of the Interior, Washington, DC.