[Federal Register Volume 60, Number 211 (Wednesday, November 1, 1995)]
[Notices]
[Pages 55592-55597]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-27078]
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DEPARTMENT OF THE INTERIOR
Summary of Minerals Management Service Workshops on Expanded Use
of Royalty-In-Kind (RIK) Procedures
AGENCY: Minerals Management Service, Interior.
[[Page 55593]]
ACTION: Summary and overview of RIK workshops.
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SUMMARY: The Minerals Management Service (MMS) recently conducted a
series of workshops to discuss ways of expanding the ongoing pilot
program for collecting in-kind royalties on natural gas produced from
Federal offshore leases. This notice contains a summary of the three
workshops held in Houston (August 22, 1995), Denver (September 11) and
New Orleans (September 15). The workshops were announced in a Federal
Register Notice on July 19, 1995 (60 FR 37070).
On January 1, 1995, MMS initiated a Royalty Gas Marketing Pilot in
the Gulf of Mexico. In the pilot, gas royalties are collected on an in-
kind basis and sold directly to gas marketing companies.
The MMS has two objectives in conducting the current pilot. First,
the MMS seeks to streamline royalty collections, and second, to test a
process which promises increased efficiency and greater certainty in
valuation. The MMS will issue an interim report on the pilot in
November 1995 and a final report by June 30, 1996.
Comments offered in the workshops were generally favorable
regarding the current pilot and were supportive of further MMS efforts
to employ similar in-kind collection procedures. The workshops provided
a useful forum for constructively discussing issues that have arisen in
the current pilot and ways of improving future RIK efforts.
The comments and suggestions offered in the three workshops are
combined into one narrative. The workshops were structured around the
following panels: (1) Requirements placed on lessees, (2) requirements
placed on purchasers, (3) contract terms and auction procedures, and
(4) considerations and recommendations for expanding RIK collections.
The following summary is organized around the principal themes which
emerged in all of the panel discussions.
Reporting and Payment Procedures
1. Producers at the workshops emphasized that major benefits of gas
RIK are reporting relief, reduced scope of audits and avoidance of
disputes over valuation issues.
2. Marketers raised concerns over reporting and payment procedures.
For example, marketers noted the awkwardness of requiring payment on
the 25th of the month following production because, by that date, the
marketers do not have the information on actual volumes. They are
obligated to pay on nominated volumes, which may differ from the volume
received. Typically, marketers don't have the information on actual
volumes until about 40 days after the end of the month. While marketers
can accommodate some differences between volumes nominated and volumes
received, large discrepancies can be a problem. If the marketers pay
for a volume of gas, they want to be assured that volume will be
allocated to them.
3. A workshop participant noted that MMS is constrained in this
issue by the fact that royalty payments are due the end of the month
following production. This fact means that MMS could postpone the due
dates to the end of the month, but not later. The argument was made
that the lessee's payment in-kind satisfies the statutory requirements
for timely payment, thus nullifying the requirement in terms of the
purchaser's obligations. However, an MMS representative observed that,
with delays in payments, the time value of money may be a concern,
particularly in any future onshore programs in which the states
eventually receive a portion of the royalty revenue forthcoming from
the RIK gas purchasers.
4. A discussion followed on the requirement that producers must
report to MMS information on RIK gas nominated each month. Producers
question MMS' need to be informed about nominated volumes.
5. Producers pointed out that flash gas still poses a reporting
burden that can be avoided. A producer attending the workshop suggested
that flash gas should be included in the royalty gas volumes to
eliminate the need to report it separately on an in-value basis.
Several workshop participants thought that flash gas volumes could be
included in the monthly imbalance account.
Producer Perspectives on Take Points for RIK Gas and Transportation
Responsibility
1. Producers generally favor the use of the Facility Measurement
Point (FMP) as the take point for the RIK gas. Several producers stated
that responsibility for transportation downstream of the FMP belongs to
the lessor or purchaser. Producers also said that the rates charged for
the use of non-jurisdictional pipelines (pipelines over which the
Federal Energy Regulatory Commission (FERC) has no regulatory
jurisdiction) should be established through arm's-length negotiation
between the producer and the purchaser. Some producers expressed the
view that in the future, the Government needs to establish a procedure
to accommodate changes in pipeline fees.
2. One producer and owner of non-jurisdictional pipelines defended
the right to negotiate a pipeline fee in excess of the amount MMS
allows as a deduction when lessees pay royalties in-value. Producers
typically do not transport third party gas on their lateral (non-
jurisdictional) pipelines, and, if they do, they negotiate rates. The
producer expressed the view that the same should apply with RIK gas.
The producer wanted to be able to receive a higher rate of return on
pipeline investment by charging negotiated arm's-length rates to third-
party marketers. The producer added that lessees cannot realize as much
return on their pipeline investments on royalty gas which is paid in
value as they can in arm's-length situations.
3. However, another producer pointed out that an attempt by
producers to charge purchasers high rates for lateral pipelines could
be counterproductive. The producer stated that, because of the benefits
to be achieved in an RIK environment, a producer would be ``cutting off
its nose to spite its face'' if it did not try to negotiate reasonable
rates with prospective purchasers. The danger of charging high rates
for lateral pipelines would be that MMS may revert to collecting the
royalties on an in-value basis. A marketer responded that a lessee may
be less inclined to charge reasonable rates if the lessee did not want
its gas taken in-kind.
4. Several producers voiced concerns about the possibility of being
forced to deliver RIK gas downstream of the FMP. One concern mentioned
was the fact that some producers have no experience in moving gas away
from the wellhead. But more common concerns revolved around bearing or
sharing costs downstream of the FMP. One producer noted that in the
design of the current pilot, there are no disputes over ``marketable
condition.'' Another producer added that if MMS were to move the take
point downstream of the FMP, disputes over transportation and
marketable condition would be rekindled. A producer made the point that
in addition to above reasons, the lessee would encounter difficulty in
taking a monetary transportation deduction in those instances in which
in-value payments are not being remitted on the property.
5. The observation was made that the MMS may have difficulty
capturing downstream value unless MMS assumes some cost and risk. Such
costs could include the provision of capital for the building of
lateral lines and expenses related to aggregation of gas production.
However, a workshop participant noted that lessors normally do not
participate
[[Page 55594]]
in production, gathering, or transportation investments.
Purchaser's Viewpoints on Transportation Obligations and Associated
Risk
1. In some cases, the purchasers of RIK gas had to make
arrangements to transport gas through non-jurisdictional pipelines.
Since the RIK gas is taken at or near the lease, the purchasers are
responsible for transportation arrangements and costs. Comments
revolved around the burdens placed on purchasers by this arrangement.
2. The point was made that most marketers are accustomed to buying
large volumes at fixed points. In the case of this pilot, marketers had
to get out maps and ``do their homework.'' Rather than deal with the
possible transportation uncertainties, one marketer focused on leases
in areas where it already had contracts.
3. The issue of negotiating the charges on non-jurisdictional
pipelines was a major focus of attention. The strong bargaining
position of producers was noted; the observation was made that gas
producers have no need to transport gas on non-jurisdictional lines
that they do not own. They also do not have to provide transportation
for others on their lines. One representative of a marketing company
observed that in the collection of royalties in-value, producers take
an allowance on royalty payments for producer-owned laterals, and MMS
knows the amount of the allowance. However, a third-party purchaser
could not base its bid on that rate, because it may not be able to
negotiate the same rate with the producer.
4. One marketer offered the idea that possibly MMS could negotiate
non-jurisdictional pipeline rates up front and publish them in the
Invitation for Bids (IFB, the contract instrument through which MMS
competitively selected purchasers for RIK gas). Another marketer
observed that a major issue is MMS' willingness to incur overhead costs
in order to reduce the risk to the marketer. However, the point was
acknowledged that the greater the task undertaken to reduce risk to
marketers, the less reduction in administrative costs the MMS can
achieve.
5. A commonly expressed view was that MMS could not force producers
to charge marketers a rate based on the transportation allowances given
for in-value royalty collection. The producers report a non-arm's-
length rate, while the rate with marketers would be an arm's-length
transaction. A marketer stated that it would be difficult to achieve a
revenue neutral RIK program if lessees are allowed to charge more for
lateral line transportation than their costs for purposes of non-arm's-
length deductions under the in-value collection system.
6. Several gas marketing firms expressed a reluctance to bear
either the transportation cost or the transportation risk associated
with the purchase of RIK gas. The point was made that the Government's
goals should be receipt of fair market value and reduction of risk
faced by the purchaser (e.g., year-long risk for fluctuations in
transportation charges). One workshop participant noted that it is not
the industry norm for marketers to assume transportation risk for one
year. Another noted that these are the most onerous contracts in the
business and added that, normally, a marketer would avoid entering into
long term contracts under conditions in which transportation terms can
change during the period covered by the contract. Another marketer
noted that in most contracts between marketers and producers,
transportation risks are shared.
7. Several gas marketers at the workshop wanted to see the
transportation burden shifted onto MMS or the producer. A workshop
participant noted that a solution would be to allow the purchaser to
net out actual costs to the index point. A marketer advanced the notion
that MMS needs to specify that costs from the wellhead to market are
the producers' and MMS' responsibility and suggested that MMS should
allow credits or refunds. In other words, the purchasers should be
allowed to deduct costs.
8. Several participants in the workshops recognized that there
would be a downside to allowing the marketers to bid a price that would
be net of actual transportation costs. A workshop participant noted
that if MMS moved the delivery points downstream, cash reimbursements
would be necessary. A deduction would also necessitate an audit
function and in some cases, litigation. One workshop participant stated
that having auditors in the marketing companies is a ``show stopper.''
Some thought that a better option could be found in a provision in the
sales contract for bi-lateral renegotiations in the event of material
changes. Another thought that quarterly sealed-bid auctions of RIK gas
may be a solution.
9. Other marketers saw the transportation cost and uncertainty in
much less critical terms and recommended solutions that would not
involve shifting costs and risk. One gas marketer suggested that much
of the problem could be alleviated if producers would guarantee access
and agree to charges in advance. Another gas marketer suggested that
one way to deal with the lateral line issue is to publish a flat rate
that MMS would allow for the charges incurred for the use of lateral
pipelines, and then let the purchasers negotiate with producers. A
marketer participating in the pilot stated that it had no problem
negotiating rates for lateral lines when it called the producers. One
marketer added that the best solution is to keep the lines of
communication open and to negotiate reasonable rates. Another marketer
asserted that all the risks involved in buying RIK gas can be managed
by marketers in their bids, if they are diligent.
10. Other marketers emphasized that part of the solution to the
issue of transportation risk can be found in allowing purchasers
greater periods of time in which to prepare bids. The view was
expressed that MMS should not focus on wellhead problems; MMS should
allow the marketers to deal with these matters as they would for any
other wellhead sale. The key is to allow enough time in the bidding
process. A marketer noted that allowing more time to respond to bids
would reduce the likelihood of bidder mistakes.
The ``Must Take'' Requirement, Gas Balancing and Gas Volume Control
1. The current pilot obligates the purchaser to take 100 percent of
the gas made available by the producer at the take point. Marketers and
producers have sharply differing perspectives regarding the ``must
take'' provision of the RIK gas contract. In general, producers insist
that this feature be included in any future pilot and also in the
implementation of a permanent program of taking royalties in-kind.
Producers attending the workshops pointed out that marketers should
prepare their bids with a full understanding of their obligation with
respect to the ``must take'' provision of the contract.
2. In commenting on production uncertainty, one marketer noted that
the IFB needs to be explicit about the fact that volumes can fluctuate;
in fact, volumes can increase as well as decrease, and both situations
may cause problems. Shut-ins are also possible. Another marketer
observed that in light of production uncertainty, the must-take
provision is too burdensome to the purchaser. Marketers must factor
into their bids the additional risk associated with the must-take
provision. If producers exercise this right with no flexibility, MMS
will suffer a revenue
[[Page 55595]]
loss as bids are adjusted to reflect the greater volume risk.
3. Specific procedures were suggested to deal with significant
variations in production. For example, the lessee could be required to
give the purchaser 60 days notice if prospective production increases
were to exceed a pre-specified amount for reasons related to reworking
of wells or development of new wells. Also a provision could be
introduced which would give the contractor the right of first refusal
for the increased volumes at the contract price. If refused, the RIK
gas would be re-auctioned. Another alternative to address fluctuations
would involve the introduction of a ``change of conditions'' clause in
the MMS contract with the marketer. The clause would allow for
renegotiation of the contract if volumes or other conditions change
significantly.
4. A workshop participant noted that a royalty owner naturally will
receive a lower value for gas than would a working interest owner
because the royalty owner has no control over production. The
suggestion was made that MMS enter into Joint Operating Agreements,
with balancing arrangements, and act as a working interest owner. The
only difference would be that MMS would not incur any operating costs.
Someone responded by noting that the idea was not feasible because the
lessor has leased away its right to control production and cannot be
involved in operations or operating decisions. Also, the lessor cannot
leave the royalty share of production in the ground and cannot share in
the costs of production.
5. The volume uncertainty faced by the purchasers prompted some to
suggest that MMS consider alternative means to warrant volumes of gas
in light of the fact that MMS has no control over production. One gas
marketer noted that MMS could guarantee volumes if it were to incur the
costs of aggregating and storing RIK gas. Even if volumes were not
warranted, MMS could reduce risk to the purchaser by bearing some costs
of pooling and aggregation.
6. Several producers raised the issue of processing contracts and
the impact of losing the one-sixth of production through the taking of
RIK gas. Plant Processing Agreements expose the participating lessees
to potential penalties and residual liability problems. The penalties
and liabilities for producers can arise if, over a period of time, one-
sixth of the production stream is diverted and taken as RIK gas. One
producer noted that under an involuntary RIK scenario, the loss of
control of one-sixth of production could be a significant problem.
Several producers stated that their processing problems were relatively
minor; one producer indicated that these problems would disappear if
greater numbers of producers were paying gas royalties on an in-kind
basis. Most plant owners would be forced to adapt processing plant
accounting procedures to accommodate the new royalty collection
procedures.
7. In some cases, purchasers would need to explore the possibility
of participating in existing gas processing arrangements. The
processing of RIK gas means that there is a potential increase in bids
because a producer would have an added incentive to retain its one-
sixth share. But this uplift could be reduced by potential problems
encountered by non-lessee bidders in making processing arrangements.
This potential difficulty may dissuade prospective purchasers from
bidding on RIK gas. However, one marketer expressed the view that
entering existing processing arrangements would not be a problem;
marketers can probably get access to plants. Someone suggested that the
IFB indicate that the gas production stream from the lease is committed
to processing. The suggestion was also made that for RIK gas which
would otherwise be committed to processing, MMS may want to specify in
the IFB a requirement that bidders provide documentation of processing
arrangements.
8. One solution offered to deal with existing gas processing
arrangements would allow producers the option of buying back their
royalty gas at the highest bid price. This option would enable
producers to maintain control over six-sixths of the volume. However, a
marketer stated that doing so would probably reduce the number of bids.
Marketers do not want to go through the effort of researching bids only
to have the producers take back the gas.
9. Several workshop participants expressed the view that problems
associated with volume uncertainty and control can be rectified by
including the necessary information in the IFB and allowing a
substantially longer period between the issuance of the IFB and the
deadline for bid submission.
Communications Between Lessee and Marketer
1. In major part, the initial communication between the winning
bidders (purchasers) and the producers was poor. Few marketers called
to inquire about the gas and lateral pipelines needed to transport the
gas. Marketers needed to know about gathering systems and charges for
laterals. Since producers did not want the marketers to have problems,
producers found it was necessary to initiate discussions in order to
arrange delivery and lateral transportation. In part, the MMS may have
contributed to this lack of communication by failing to include in the
IFB (which became the contract), the name of the producer's designated
liaison along with the telephone number.
2. One producer made the point that communication will almost
certainly be better in future pilots. Marketers will be more alert to
their own responsibilities in making appropriate transportation
arrangements.
Contract Terms and Sealed-Bid Auction Procedures
1. Questions were asked and suggestions offered concerning
additional information which should be included in the IFB. For
example, the suggestion was made that the IFB should give meter numbers
and exact locations of the FMP or take point. Information on gas flow,
Btu content, and non-jurisdictional or lateral pipelines should be
included.
2. Questions were posed concerning the absence of meter number
information and the designation of the FMP as the ``take point'' for
the RIK gas. The MMS representative from the Gulf of Mexico Regional
Office explained that the FMP number identifies a measuring station for
the facility; it does not change. Meter numbers can change and thus
were not used. The view was expressed that future IFB's need to be more
explicit concerning gas purchaser's responsibility with respect to
transportation. Also, an explicit statement must be included in the IFB
indicating the policy with respect to transportation allowances.
3. Some discussion focused on alternative prices which could be
used as a basis of bid formulation. One panelist stated that he prefers
the use of published price indices, and that MMS should have the
applicable producer recommend the index for each lease. Another
panelist expressed concern over the volatility of price indices and
suggested that MMS consider fixed price contracts, a mix of pricing
methods, or the use of different methods for different bids groups. One
workshop participant stated that MMS would obtain the highest price if
it were able to specify one correct index. The point was made that a
sound guide in determining the correct price index is to follow the
flow of gas through the appropriate pipeline.
4. A marketer noted that the use of the New York Mercantile
Exchange (NYMEX) futures price could be a
[[Page 55596]]
problem onshore, because there is volatility of local price indices
relative to NYMEX price in some areas. The price indices which appear
in Inside FERC, Natural Gas Intelligence, and other publications
indicate market value much closer to the lease, but still involve some
risk related to upstream transportation costs.
5. Suggestions were offered to deal with situations in which
several different price indices can be considered correct. Someone
suggested that MMS explicitly offer bidders a choice of price indices,
specifying in advance the procedure to be used by MMS in evaluating the
differentials between the indices. But this idea was contested by the
observation that if MMS offers a choice, people will try to use changes
in the differentials to minimize payments to MMS. The creation of a
``basket'' or average index was also suggested for those situations in
which several indices may work equally well. However, this suggestion
was met with skepticism and the observation that one appropriate index
would serve better as a basis bid formulation.
6. Several comments were offered on the size of gas royalty
production packages to be offered in future RIK auctions. Several
workshop participants observed that if MMS were to offer increased bid
volumes (in groups), the packages of RIK gas would be made more
attractive and would lower the per-unit risk to the purchaser. This
approach could alleviate the volume warranty problem mentioned above.
Several workshop participants suggested that the packages offered in
future RIK pilots should be at least 2-3 MMcf (million cubic feet) per
day, and preferably 5 to 10 MMcf per day. Typical volumes in the Outer
Continental Shelf gas spot market range from 5 to 10 MMcf per day. A
marketer added that all RIK gas in a package should flow into one price
index point.
7. The subject of aggregation prompted some discussion of the
alternate bid procedure made available to bidders in the current pilot.
The alternate bid procedure allowed bids on self selected aggregations
of groups. The bids would have taken the form of an ``across the
board'' adjustment to the applicable price indices for the respective
groups. Such bids would win the gas in the aggregation if the alternate
bid were to exceed the total value of the highest individual bids or
next highest alternate bid for any of the groups in the aggregation.
The MMS was surprised by the apparent lack of interest in the alternate
bid procedure. Marketers explained this lack of interest by noting the
variation in lateral pipeline rates and costs over different fields.
These differences between gas fields in the Gulf of Mexico dissuaded
prospective bidders from applying an ``across the board'' adjustment to
indices in the formulation of bids.
8. Marketers expressed an interest in an option that would allow
prospective bidders to put together their own aggregations and allow
differential bids (adjustments to the applicable index) for gas from
different leases. The problem of bid ranking faced by MMS was noted
with respect to this option.
9. Some marketers thought the financial qualification criteria for
bidders were restrictive for small companies. One marketer observed
that perhaps MMS could offer companies the option of providing letters
of credit. Of course, this would be an added cost, unless the letter of
credit was backed with an interest-bearing cash deposit. The suggestion
was also made that the letter of credit need not cover the entire
period of the contract. A letter of credit could cover a shorter period
during which MMS is actually at risk. Another commenter stated that
prior business experience was not necessarily a good indicator of
credit worthiness, and that a better option would be to require all
bidders to post a bond. Other comments included the suggestion that MMS
require an escrow account and the proposal that factors other than
prior business experience be used as a criterion in establishing credit
worthiness; the assets held by the company would be one such example.
One commenter stated that, regardless of the method selected, the
requirements should be the same for all bidders.
Views on Future Pilot Expansion and RIK Efforts
1. Some workshop participants suggested MMS form a study group of
current pilot participants to design the next pilot or program.
2. Several workshop participants suggested that MMS become more
involved in the marketing of the gas. The point was made that because
of the potentially large volume of RIK gas, MMS can enhance its
revenues by pooling and aggregation. One marketer said the MMS should
forget about its aversion to getting into the market place. The MMS has
shown the ability to learn concepts and practices; why wouldn't MMS be
able to gain expertise in gas marketing? If MMS were to market its gas,
it could realize maximum value. Another marketer observed that MMS
should learn to market gas, or hire someone to market its gas, if it
wants to receive highest value. However, one participant noted that MMS
would increase its administrative costs if it were to become more
involved in the marketing of in-kind royalty gas.
3. Several producers suggested that future RIK regulations and
procedures should be based on the Volunteer Agreement between MMS and
participating lessees, as employed in the current pilot.
4. Strong support was voiced for an expanded pilot in the Gulf of
Mexico, regardless of results obtained in the current pilot. A larger
pilot, incorporating lessons learned from the current pilot would
provide needed data.
5. Workshop participants voiced a diversity of opinions concerning
the time of year in which to commence a another pilot. However, a
consensus seemed to hold the view that a pilot should commence in one
of the summer months. The program should be in place when companies are
making arrangements for the winter season.
6. Several comments were offered concerning the administrative
savings that MMS is likely to realize with RIK procedures. For example,
the point was made that a full scale implementation of RIK would be
necessary for MMS to realize major administrative savings. Partial
implementation would require MMS to maintain an audit, valuation,
reporting infrastructure for the royalties being paid in value. Also,
full scale implementation would reduce problems created for lessees and
operators by having some lessees paying royalties in value and others
paying royalties in kind.
7. Support was expressed for an ``evergreen option'' in the
awarding of gas marketing contracts. This option would involve a
routine renewal of contracts. Such an option would be feasible under
Federal contracting procedures if the renewal provision were pre-
specified for a fixed number of years.
8. Some discussion focused on complications which may be
encountered in expanding the pilot to onshore gas royalties. For
example, one workshop participant noted that onshore gathering costs
may be a problem because third parties may not have any rights to
transport gas upstream of plants. Higher costs may also arise in the
San Juan basin, in part, because of the prevalent use of stainless
steel pipelines.
9. The possibility of an oil RIK pilot was discussed. Much of the
interest in such a pilot seemed to come from those participating in the
current oil RIK program. The current oil RIK program is
[[Page 55597]]
very unpopular among lessees; many at the workshops suggested that the
current oil RIK program be replaced with a program designed along the
lines of the current gas RIK pilot. Note was taken of the fact that the
latter step could only be taken if the Secretary of the Interior were
to make a determination that small refineries in the selected area have
access to adequate supplies of crude oil at ``reasonable prices.''
FOR FURTHER INFORMATION CONTACT: Mr. Hugh Hilliard, Minerals Management
Service, Mail Stop 4013, 1849 C Street, NW., Washington, DC 20240,
telephone number (202) 208-3398; or contact Mr. James McNamee, Minerals
Management Service, 12600 West Colfax, Lakewood, Colorado 80215,
telephone number (303) 275-7126.
Date: October 25, 1995.
Lucy R. Querques,
Associate Director for Policy and Management Improvement.
[FR Doc. 95-27078 Filed 10-31-95; 8:45 am]
BILLING CODE 4310-MR-P
