Avcg, LLC v. State

• Docket Number: Supreme Court No.: S-18170
• Decision Date: 07 April 2023
• Parties: AVCG, LLC, Appellant, v. State of Alaska, DEPARTMENT OF NATURAL RESOURCES, Appellee.
• Court: Alaska Supreme Court

527 P.3d 272

AVCG, LLC, Appellant,

v.State of Alaska, DEPARTMENT OF NATURAL RESOURCES, Appellee.

Supreme Court No.: S-18170

Supreme Court of Alaska.

April 7, 2023

Louisiana W. Cutler, Joan M. Travostino, and Siena M. Caruso, Dorsey & Whitney LLP, Anchorage, for Appellant.

David A. Wilkinson, Senior Assistant Attorney General, Anchorage, and Treg R. Taylor, Attorney General, Juneau, for Appellee.

Before: Winfree, Chief Justice, Maassen, Carney, Borghesan, and Henderson, Justices.

OPINION

BORGHESAN, Justice

I. INTRODUCTION

Alaska Venture Capital Group, LLC (AVCG) owned interests in oil and gas leases on state lands on the North Slope. AVCG sought the State's¹ approval to create overriding royalty interests on the leases. ² The Alaska Department of Natural Resources, Division of Oil and Gas denied AVCG's requests, explaining that the proposed royalty burdens jeopardized the State's interest in sustained oil and gas development. AVCG appealed. Five years later the DNR Commissioner affirmed. The superior court then affirmed the Commissioner's decisions. AVCG now appeals to us.

AVCG's primary argument is that the decisions improperly adopted a new regulation that did not undergo the rulemaking procedures of Alaska's Administrative Procedure Act (APA). AVCG maintains that DNR's reliance on specific factors — in particular, the fact that the proposed ORRIs would create a total royalty burden of over 20% on the leases — amounted to adopting a regulation. But applying existing statutory and regulatory standards to the particular facts of the case and explaining the importance of those facts in the analysis did not amount to a new regulation. The 20% figure was a standard developed through a series of past adjudications, not a new standard that required rulemaking.

AVCG also argues that the decisions lacked a reasonable basis in fact and law and that, for some of its leases, no agency approval was required at all. We reject both arguments. The decisions to deny ORRIs had a reasonable basis, especially in light of missed production deadlines for some leases and the developmental stage of others. AVCG's argument that it did not need approval to create ORRIs on some leases is inconsistent with the language of and policy behind the applicable regulation.

Finally, AVCG raises constitutional claims. It argues that delay and an "ad hoc" decision-making process violated its procedural due process rights. But AVCG fails to establish prejudice arising from the delay, and the case-by-case exercise of discretion is both appropriate and required by regulation. It also argues that the denials constituted an uncompensated taking. Because AVCG's right to create ORRIs was expressly conditioned on DNR approval, lawfully denying this approval did not deprive AVCG of any property interest.

We affirm the superior court on all issues.

II. FACTS AND PROCEEDINGS

A. Oil And Gas Security Interests

This matter concerns three types of oil and gas security interests. Landowners that lease their lands for hydrocarbon production, including the State, typically reserve a royalty interest in production.³ Royalty interests are independent from the costs of production.⁴ The royalty owner receives a set fraction of the gross revenue the lessee receives from producing oil and gas.⁵

The lessee typically has a working interest, an ownership share that conveys the right to explore, drill, and produce oil on the leased lands.⁶ The owner of a working interest receives a share of production revenues that remain after royalties are paid.⁷

Finally, an overriding royalty interest (ORRI) is an additional royalty carved out from a lessee's working interest.⁸ The owner of an ORRI is entitled "to a percentage of royalties from the oil and gas produced by the lease at the surface, when and if the lease becomes productive."⁹ Like royalty interest owners, ORRI owners receive a fraction of proceeds from a lease without contributing to development or operations.¹⁰ Adding an ORRI to an existing royalty interest reduces working interest holders’ net revenue without decreasing production costs, increasing the ratio of risk to reward for developing a lease.¹¹ If a high royalty burden siphons too much profit from working interest owners, then they may lack adequate incentive to develop the prospect or to continue production when recovery becomes more expensive, especially in the event of changing economic conditions.¹²

The legislature has created a program of leasing state lands for oil and gas production, providing that "the people of Alaska have an interest in the development of the state's oil and gas resources to (A) maximize the economic and physical recovery of the resources; (B) maximize competition among parties seeking to explore and develop the resources; and (C) maximize use of Alaska's human resources."¹³ Pursuant to this program, the Division may approve transfers of interests in state oil and gas leases, including transfers that entail the creation of ORRIs.¹⁴ However, "[n]o transfer of an interest in a lease, oil and gas exploration license, or permit, including assignments of working or royalty interest, operating agreements, and subleases, is binding upon the state unless approved by the commissioner."¹⁵ The Division will approve transfers "unless the commissioner makes a written finding that the transfer would adversely affect the interests of the state."¹⁶ Once the Division approves a new ORRI, the owner of that ORRI may transfer it to others without seeking further approval.¹⁷

B. AVCG's Proposals

In August 2014 AVCG and other working interest owners asked the Division to approve two agreements concerning two sets of oil and gas leases on the North Slope. Five leases jointly operated as the Southern Miluveach Unit (SMU) comprised AVCG's first set of working interests. AVCG also held full or partial working interests in 34 undeveloped leases. Each agreement proposed (1) assigning working interests to a group of purchaser entities and (2) creating ORRIs that AVCG and others would retain as partial compensation for the working interest transfer.

The Division asked Brooks Range Petroleum Corporation (Brooks Range), another developer that operated the SMU leases on behalf of AVCG and other working interest holders, to share details that would inform the Division's response to the proposed ORRIs. In an email to Brooks Range, the Division noted that the requested ORRIs would reduce the working interest holders’ net revenue interest¹⁸ to 77.5% for the SMU leases. The Division requested "an explanation as to how approving the ORRIs will not adversely affect the interests of the state, particularly with regards to the ability of working interest owners to explore and develop the leases."

Brooks Range responded to the Division's queries with a brief email and, later, a letter recommending that the Division approve AVCG's ORRI application. Brooks Range's initial email suggested that ORRIs already existing on the SMU leases would not burden the exploration and developments of those leases and that the proposed additional ORRIs would not hinder development because the entities that would hold the ORRIs also owned working interests. A more comprehensive set of arguments followed in Brooks Range's October 2014 letter. The October letter reiterated that the ORRIs already burdening the SMU leases did not preclude exploration and stated that the purchasing parties had accounted for the proposed additional ORRIs in their economic models. Brooks Range asserted that the proposed ORRIs would promote state interests by permitting the sellers to agree to a lower upfront cash payment — leaving the purchasers extra capital with which to develop the leases.

C. The Division's Decisions

The Division issued a decision regarding the SMU leases in October 2014 and a decision on the 34 undeveloped leases in March 2015. For both sets of leases the Division approved working interest transfers but denied the proposed ORRIs. The Division issued a detailed memo explaining each decision.

When the Division rejected AVCG's application to create new ORRIs on the SMU leases, it emphasized that the "specifics of the application[ ] and the activity in the unit" would drive its analysis. The Division explained that the proposed ORRIs "would leave current and future [working interest owners] with only 77.5% of the production revenue while bearing 100% of the costs of exploration and development." The proposed ORRIs, if approved, would "persist as long as the leases exist." Therefore, the Division explained, even if the current working interest holders were willing to operate under a high royalty burden, new ORRIs could discourage future assignment of the working interests. The Division also chronicled the applicants’ exploration activities prior to their ORRI application. It pointed out that the developers had failed to drill any wells during the unit approval period despite multiple deadline extensions and that the applicants had failed to provide required documentation.

The Division also responded to points in Brooks Range's letter. The Division noted that the applicants failed to address the long-term impacts of new ORRIs and their effect on the possibility of future assignments to new working interest owners. The Division concluded that "the likelihood that, in the long-term, an ORRI burden of this magnitude would discourage exploration and development of these leases, and that the economic limit would be reached prematurely, creates a risk that is great enough to adversely affect the state's interests."

The Division also denied proposed ORRIs on AVCG's 34 undeveloped leases. Additional ORRIs, the Division wrote, would drop the working interest owners’ net revenue interest from a range of approximately 78.3% to 83.3% across the leases to a range of 75.8% to 79.8%. As with the SMU leases, the Division found that this low net revenue interest, compounded by other concerns about the leases’ long-term economic viability,...