Marathon Oil Co. v. United States

• Decision Date: 20 February 1985
• Docket Number: Civ. No. A 83-208.
• Citation: 604 F. Supp. 1375
• Parties: MARATHON OIL COMPANY, Plaintiff, v. UNITED STATES of America; United States Department of the Interior, Donald Hodel, Secretary of the Interior; Esther Wunnicke, Commissioner of The Department of Natural Resources, State of Alaska; Cook Inlet Region, Inc., an Alaska Corporation, Defendants. COOK INLET REGION, INC., an Alaska Corporation, Counterclaimant, v. MARATHON OIL COMPANY, an Ohio Corp., Counterdefendant.
• Court: U.S. District Court — District of Alaska

604 F. Supp. 1375

MARATHON OIL COMPANY, Plaintiff, v. UNITED STATES of America; United States Department of the Interior, Donald Hodel, Secretary of the Interior; Esther Wunnicke, Commissioner of The Department of Natural Resources, State of Alaska; Cook Inlet Region, Inc., an Alaska Corporation, Defendants.

COOK INLET REGION, INC., an Alaska Corporation, Counterclaimant, v. MARATHON OIL COMPANY, an Ohio Corp., Counterdefendant.

Civ. No. A 83-208.

United States District Court, D. Alaska.

February 20, 1985.

Robert L. Richmond, Richmond & Associates, Anchorage, Alaska, Robert J. Kapelke, Gorsuch, Kirgis, Campbell, Walker & Grover, Denver, Colo., for plaintiff Marathon Oil.

Michael Spaan, U.S. Atty., Anchorage, Alaska, Peter Schaumberg, U.S. Dept. of the Interior, Michael W. Reed, U.S. Dept. of Justice, Washington, D.C., for federal defendants.

Steve C. Hillard, Munger, Tolles & Rickershauser, Anchorage, Alaska, William D. Temko, Munger, Tolles & Rickershauser, Los Angeles, Cal., for defendant Cook Inlet Region, Inc.

Mark P. Worcester, Asst. Atty. Gen., Dept. of Law, Anchorage, Alaska, for defendant State of Alaska.

JAMES M. FITZGERALD, Chief Judge.

Plaintiff Marathon Oil Company owns an undivided fifty percent working interest in certain oil and gas leases in the Kenai Field Unit in Alaska. Marathon and its working interest associate, Union Oil Company of California, discovered natural gas in the Kenai field in 1959, and production commenced in 1961.

During 1982, a representative year, the production of the Kenai field was delivered to a number of different purchasers. Approximately 16% was delivered to a liquefied natural gas (LNG) plant at Nikisi, Alaska owned by Marathon and Phillips Petroleum Company. Over 42% of Kenai field gas was delivered to an ammonia and urea plant at Mikisi owned by Collier Chemical Company, a subsidiary of Union Oil Company. Over 31% of production was sold to Alaska Pipeline Company under a long-term contract for distribution in the Anchorage market. About 9% of the gas was rented to the Swanson River Field Unit for pressure maintenance. A small portion of the gas was sold under contract to the City of Kenai, and a portion was used in production operations in the Kenai field.

Each of the defendants, the United States, the State of Alaska, and Cook Inlet Region, Inc. (CIRI), is entitled to receive royalties on gas produced in the Kenai field. There are both federal leases and state leases in the Kenai field. The leases are of four types: (a) leases which were originally federal leases covering lands later conveyed to the state pursuant to the Statehood Act;¹ (b) leases which were originally federal leases covering lands later conveyed to CIRI pursuant to the Alaska Native Claims Settlement Act (ANCSA);² (c) federal leases covering lands currently held by the United States; and (d) state leases covering lands currently held by the state. All of the federal leases provide that Marathon shall pay 12½% royalty on the reasonable value of production from the leased lands. Alaska does not directly receive royalties from production attributable to the federal leases. However, under a provision of the Mineral Lands Leasing Act,³ Alaska is entitled to 90% of all royalties received by the United States from oil and gas production on federal lands in the Kenai field.

A dispute arose in 1977 between Marathon and the United States Geological Survey (USGS)⁴ as to the proper method of computing the reasonable value, for royalty purposes, of that part of gas production from federal leases delivered to the LNG plant. Gas delivered to the plant is cooled through a multi-step cooling process to transform it into a liquid. The liquefied natural gas (LNG) is then transported by tanker to Japan where it is sold to two utility companies. Marathon had been computing royalties on this gas on the basis of the price paid for Kenai field gas under the long-term contract with Alaska Pipeline Company. In 1977 USGS took the position that royalty value was to be established on the basis of the sales price for LNG in Japan less expenses.⁵

To resolve the dispute, Marathon and the USGS entered into an agreement on February 6, 1981, retroactive to January 1, 1980.⁶ The settlement agreement provided that royalties were to be computed using the "Phillips formula" which had been developed for use by Phillips Petroleum Co. in computing royalties due the state of Alaska under state leases for gas delivered to the LNG plant at Nikisi. Under the Phillips formula, Marathon was to pay royalties based on 36% of the per MMbtu price received in Japan for the LNG (less certain adjustments). In addition, Marathon paid USGS $1,834,160.83 representing additional royalties due from January 1, 1980 through February 1981. The settlement agreement was, by its terms, effective "until such time as changes in market conditions, State or Federal law, or regulations adopted thereunder ... necessitate a revision in the method used to determine the wellhead value."⁷

On January 6, 1983, the Minerals Management Service (MMS) notified Marathon of MMS's intention to redetermine the reasonable value for computing royalties on gas delivered to the LNG plant.⁸ The letter stated that the basic net back valuation theory by which the reasonable wellhead value was derived from the sales price in Japan was sound, but that adjustments were necessary to reflect changing costs and prices due to economic conditions. MMS proposed to update the coefficients in the Phillips formula to reflect current processing and transportation costs.

The letter also informed Marathon that MMS would hold a public hearing on the matter in Anchorage, and that Marathon had thirty days to file written comments, evidence, and legal argument. Moreover, Marathon would have an opportunity at the hearing to present its views to MMS. A public hearing was held in Anchorage on March 1, 1983, and at that time Marathon appeared and offered information on its own behalf.⁹

Based on the hearing, written comments, and other materials, MMS on July 8, 1983 issued an order to Marathon directing the company to begin paying royalties as of August 1, 1983 based on the revised computations.¹⁰ Marathon did not comply but filed an appeal of the July 8 order. In substance, Marathon disputed MMS's authority to redetermine the royalty basis, claiming that by notifying Marathon of the intended change in computation, MMS had repudiated the settlement agreement based on the Phillips formula. Moreover, effective April 1, 1983, Marathon unilaterally rolled back the basis on which royalties on gas delivered to the LNG plant were computed to presettlement rates. That is, rather than following the formula of 36% of the price received in Japan, which had been in effect since January 1980, Marathon began to compute royalties based on the longterm contract price paid by Alaska Pipeline Company for Kenai field gas.

Under the July 8, 1983 order of MMS, Marathon was required for royalty purposes to compute the value for gas delivered to the LNG plant at $3.00/Mcf. By the terms of the settlement agreement based on sales of LNG in Japan, Marathon in the period immediately prior to April 1, 1983 computed the value of gas for royalty purposes at $1.71/Mcf. After that date, Marathon computed the value of gas at $.61/Mcf based on the contract price for Kenai field gas paid by Alaska Pipeline Company.

After MMS learned Marathon had unilaterally rolled back the price effective April 1, 1983, the agency issued a second order, dated October 5, 1983, directing Marathon to compute the value of gas for royalty purposes under the settlement or Phillips' formula for the months of April through July 1983.¹¹ Once again, Marathon did not comply with the MMS order. Finally, on June 11, 1984, the Department of the Interior (DOI) issued a third order directing Marathon to comply with the previous orders of MMS.¹²

Marathon filed a complaint in this court on April 14, 1983 challenging the revised valuation method proposed by MMS. The original complaint has been amended to challenge the three DOI orders issued after the complaint was filed.¹³ In its amended complaint, Marathon now seeks declaratory relief to resolve the actual controversy among the parties involving the proper method of determining the wellhead value of the natural gas for royalty purposes. Apart from that, Marathon seeks redress for breach of lease provisions, for an accounting, for restitution, and to secure Marathon's rights under the United States Constitution and the Alaska Constitution.

The federal government in answer to the amended complaint denies that Marathon is entitled to relief for any of its claims and seeks to have the claims dismissed. In a counterclaim, the federal government contends that effective August 1, 1983, Marathon was required to compute royalties on production delivered to the LNG plant in accordance with the MMS orders. Under those orders, the reasonable value of gas at the wellhead is deemed to be $3.00/Mcf, as opposed to the $.61/Mcf value used by Marathon since April 1983. Moreover, the government requests that Marathon be required to pay $717,705 as unpaid royalties on production for the period from April through July 1983 computed using the Phillips formula. Since Marathon has persistently failed to comply with the applicable statutes, regulations, and terms of its leases, the government requests an order from this court cancelling the leases and requiring Marathon to account for all royalty payments due and for judgment in the proper amount.

On October 1, 1984, the federal government requested that a preliminary injunction issue in this case to compel Marathon to pay the royalties on production delivered to the LNG plant in accordance with the MMS orders. A conference was held on December 3, 1984 to expedite the case and a schedule was agreed to for the filing of motions addressing the merits. The federal government...