Devon Energy Corporation v. Dirk Kempthorne

Facts

Through its Minerals Management Service (MMS), D issues and administers leases authorizing the removal of natural gas from federal land. The producer-lessees must pay the government-lessor 'a royalty at a rate of not less than 12.5 percent in amount or value of the production removed or sold from the lease.' In the Federal Oil and Gas Royalty Management Act, D was instructed by Congress to create a comprehensive inspection, collection, accounting, and auditing system to ensure that the government receives the royalties owed. D has the authority 'to prescribe necessary and proper rules and regulations and to do any and all things necessary to carry out and accomplish the purposes of' the Act. D issued a number of regulations governing the royalty valuation process. The 1988 regulations establish the framework for calculating the royalty value of the coalbed methane gas production at issue here. royalties are calculated on the basis of the total value a lessee receives for its production. The regulations specify that the 'value of production' should be no less 'than the gross proceeds accruing to the lessee for lease production,' minus certain allowable deductions. D regulations have long interpreted the Mineral Leasing Act to require lessees to put the gas into marketable condition at no cost to the United States -- the so-called 'marketable condition rule.' The 1988 regulations confirmed this requirement. Marketable condition is a 'lease product which is 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.' A lessee may deduct its actual costs of transporting the gas from the wellhead to the point of sale when gas produced from the lease is sold at a market remote from the lease. This 'transportation allowance' includes 'only those costs which are directly related to the transportation of lease production.' A transportation allowance is 'an allowance for the reasonable, actual costs of moving [gas] to a point of sale or delivery of the lease . . . or away from a processing plant.' P leases land with coalbed methane. After the gas leaves a CDP (central delivery point), it goes through a complex series of compression and dehydration processes as it travels 'downstream' to a processing plant in preparation for eventual sale. The gas is pressurized and then enters a dehydrator, which removes water and then downstream into another compression to 1,200 psi. Excess carbon dioxide is removed, the gas is dehydrated, and the gas is compressed from approximately 800 psi to 1,100 psi. At that pressure, D delivers the treated gas into one of two lateral pipelines. The gas is transported to various purchasers through these pipelines. On April 22, 1996, MMS's Associate Director for Royalty Management distributed a 'Dear Operator' letter detailing how to calculate royalties on coalbed methane production. Producers were told that they could include the costs of dehydration occurring after metering at the royalty measurement point in their transportation allowance but they cannot deduct costs of dehydration occurring at the wellhead. They could include costs for compression occurring downstream of the royalty measurement point, to the extent the compression is necessary for transportation. This includes compression at the CDP and in the transportation system to the [carbon dioxide] removal facility. D found that statements in the guidance documents were either ambiguous or reflected an incorrect application of the marketable condition rule. It held that P's deductions of the costs of dehydration and of compression performed at the screw compressors, the reciprocating compressors, and the Buckshot Plant were inconsistent with the marketable condition rule because the compression and dehydration functions were necessary to put the production into marketable condition. To meet the requirements of the 'sales contract[s] typical for the field or area,' P had to compress the gas to pipeline pressure. D held that P has not shown that the dehydration performed after the reciprocating compressors and at the Buckshot Plant is for anything other than what is required to put the production into marketable condition and what is necessary for it to meet pipeline and purchaser requirements. A final order was issued where D demanded payment for all the “improper deductions” and P filed suit. The District Court granted D's cross-motion for summary judgment.

Issues

Rule of Law

Holding and Decision

Legal Analysis

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