Federal Court Says Interior Can't Limit Royalty Waivers

A federal judge has ruled that the Interior Department cannot limit royalty incentives on some Gulf of Mexico petroleum leases when energy prices are high -- a decision that could jeopardize billions in industry payments to the federal government.

Judge Patricia Minaldi of the U.S. District Court for the Western District of Louisiana ruled in favor of Kerr-McGee Oil and Gas Corp., which had sued Interior's Minerals Management Service accusing the agency of wrongly imposed price thresholds on deepwater leases issued between 1996 and 2000.

The leases' price-threshold clauses end royalty waivers when oil and gas prices exceed certain limits.

The case stems from a 1995 law, aimed at spurring costly deepwater drilling projects, that provided "royalty relief" on large amounts of gulf oil and gas production. Kerr-McGee, purchased last year by Anadarko Petroleum Corp., challenged an MMS order seeking millions of dollars in payments.

"The Interior has no discretion to enact a price thresholds requirement that applies to volumes below the minimum level of royalty-free production," Minaldi said in an Oct. 18 ruling filed this week.

"Because the Interior imposed price threshold requirements on Kerr-McGee's eight deepwater leases that would require Kerr-McGee to pay millions of dollars in royalties before it had even produced the minimum volume of royalty-free production, the Interior exceeded its congressional authority," Minaldi wrote.

MMS in 2006 sought $157 million from Kerr-McGee for gas produced in 2003 and both oil and gas produced in 2004.

But the decision could affect vastly greater sums. MMS has estimated that if price thresholds on leases from 1996-2000 are found unlawful, it could lead to $60 billion in waived royalty payments. However, a Government Accountability Office report earlier this year found that this estimate may be too high (Greenwire, April 13).

Interior's top lawyer said agency officials "fundamentally disagree" that the 1995 royalty law blocks Interior's discretion to impose price thresholds. The agency may appeal.

"The department does not believe Congress intended to provide royalty-free oil regardless of the price for leases executed between Nov. 28, 1995 and Nov. 28, 2000," Interior Solicitor David Bernhardt said in a statement. "We are exploring every option including appealing and continuing to work with Congress to resolve this."

Anadarko welcomed the decision in a statement yesterday. "The court upheld what we believe was the intent of Congress to assure that companies were afforded the royalty treatment it granted as an incentive to make huge investments in the deepwater Gulf of Mexico frontier," Anadarko CEO Jim Hackett said.

Royalty questions abound

The decision adds new uncertainty to ongoing questions about royalty payments from deepwater gulf leases.

MMS failed to include price thresholds in deepwater leases issued in 1998 and 1999, which federal officials call an oversight. A half-dozen companies -- including BP and Royal-Dutch Shell -- late last year reached a voluntary agreement with Interior to apply price thresholds to future production from these leases.

It is not clear whether the new court ruling will affect the voluntary agreements these companies reached. BP declined comment this morning, while inquiries to several other companies that signed the agreements were not returned at press time. Several dozen other companies have not reached agreements.

Interior's handling of the issue has attracted criticism on Capitol Hill, where lawmakers have floated several plans to address these contracts.

Energy legislation the House approved in August would bar companies holding 1998-1999 leases from purchasing new leases unless they agree to rework the late 1990s contracts or pay other fees.

A competing Senate energy bill does not include this provision. But a major energy tax plan the Senate Finance Committee approved in June would levy a new excise tax on gulf producers while allowing credits against the tax for royalties paid. This would effectively require new payments from producers that hold the late 1990s leases.

The committee's energy tax plan was turned back on the Senate floor in a close vote. The two chambers are currently negotiating on a final energy bill that Democratic leaders hope to approve this year.

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