Gulf Oil Corp. v. Comm'r of Internal Revenue
| Decision Date | 21 July 1986 |
| Docket Number | Docket No. 22499-82. |
| Citation | 87 T.C. No. 9,87 T.C. 135 |
| Parties | GULF OIL CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner acquired undivided interests in oil and gas leases located in the Gulf of Mexico before and during the taxable years at issue. Delay rentals were paid within each of the taxable years at issue. These payments allowed Gulf to drill, explore and produce minerals from any portion of the lease. Petitioner claimed ‘abandonments and extraordinary retirements‘ as to the leases in the Gulf of Mexico on its Federal tax returns for the taxable years 1974 and 1975 in the respective amounts of $35,651,455 and $108,108,366. The properties allegedly abandoned consisted of potential mineral deposits within the leases and did not, in any instance, consist of an entire lease.
HELD, petitioner did not sustain a loss deductible under section 165 as it failed to evidence its intention to abandon the properties. CRC Corp. v. Commissioner, 693 F.2d 281 (3d Cir. 1982), affg. on this issue Brountas v. Commissioner, 73 T.C. 491 (1979). J. Waddy Bullion, Emily A. Parker, Sean T. Crimmins, Buford P. Berry, J. Y. Robb III, and Margaret S. Alford, for the petitioner.
Raymond L. Collins and William B. Lowrance, for the respondent.
The Commissioner determined deficiencies in petitioner's Federal income tax for the taxable year 1974 in the amount of $80,813,428 and for the taxable year 1975 in the amount of $166,316,320. Petitioner and respondent, by motion granted on November 10, 1983, agreed that certain issues would be severed and tried at a special trial session, which was held at Dallas, Texas.
One of the group of issues tried was designated by the parties as ‘Worthless Properties.‘ The issues included are: (1) whether certain of Gulf's interests in offshore leases were abandoned in the taxable years at issue, thereby giving rise to deductions under section 165;1 and (2) if such deduction is established, the amount of Gulf's basis in each lease (lease bonus plus geological and geophysical costs, where appropriate) which is properly allocable to such worthless operating mineral interests.
Some of the facts have been stipulated. The stipulation of facts and accompanying exhibits are so found and incorporated herein by reference.
Gulf Oil Corporation (hereinafter referred to as petitioner or Gulf) is a corporation organized under the laws of the Commonwealth of Pennsylvania with its principal office in Pittsburgh, Pennsylvania. During the taxable years 1974 and 1975, Gulf and certain of its subsidiary corporations constituted an ‘affiliated group‘ as that term is defined in section 1504. Petitioner, directly and through its foreign subsidiaries and affiliates, is engaged in world-wide exploration, development, production, purchase, and transportation of crude oil and natural gas, and in the manufacture, transportation, and marketing of petroleum products.
Petitioner maintained its books of account for the taxable years 1974 and 1975 on the accrual method of accounting using the calendar year as its taxable year. Gulf, as the common parent of an affiliated group of corporations, timely filed consolidated Federal income tax returns for its taxable years 1974 and 1975 on behalf of itself, and certain of its subsidiary corporations, with the Office of the Internal Revenue Service at Pittsburgh, Pennsylvania. On its consolidated corporate tax returns for the taxable years 1974 and 1975, Gulf claimed ‘abandonments and extraordinary retirements‘ with respect to properties in the Gulf of Mexico in the amounts of $35,561,455 and $108,108,366, respectively.
The properties at issue are blocks of land in the Gulf of Mexico that have been leased from either the United States or Louisiana because of the value of the underground minerals. The geology of the area varies. A large cenozoic basin covers much of the coastal area of onshore Texas and all of the offshore Texas and Louisiana areas. This cenozoic basin is surrounded by a series of mesozoic basins, which range from the Rio Grande embayment near the Texas-Mexican border, to the East Texas basin north of the Sabine uplift in East Texas, to the Mississippi interior basin, which includes much of southern Mississippi and much of northern Louisiana, and to the eastern part of the Gulf of Mexico and peninsular Florida. The cenozoic basin containing the offshore Louisiana area is much younger and very different structurally from the older mesozoic basins such as the mesozoic basin in the eastern part of the Gulf of Mexico. The main geologic difference between the offshore Louisiana area and the eastern Gulf of Mexico is that in offshore Louisiana there are many thousands of feet of porous potentially hydrocarbon-bearing sands (hereinafter referred to as mineral deposits) alternating with shale, whereas in the eastern Gulf of Mexico the porous sections that have the potential of containing oil and gas reservoirs are not very numerous but are more concentrated.
To reflect the different underlying geology and potential for mineral production, the Gulf of Mexico is divided by petitioner into a number of ‘areas.‘ Two such offshore areas are the offshore Louisiana area and the MAFLA offshore area. The offshore Louisiana area is, as the name implies, located off the coast of Louisiana. MAFLA is an acronym for Mississippi, Alabama, and Florida. The MAFLA offshore area is located in the eastern Gulf of Mexico adjacent to these three states. The properties at issue are contained within one or the other of these two areas as detailed below.
Gulf was one of the first companies to explore for oil and gas in the Gulf of Mexico, beginning in the early 1950's. The Gulf of Mexico has been one of the primary exploration areas for Gulf throughout the company's history. Gulf has enjoyed considerable success in its Gulf of Mexico drilling and exploration program conducted within leases of land containing mineral deposits. By 1972, the offshore Louisiana area of the Gulf of Mexico had been the subject of extensive exploration by petroleum companies such as Gulf. Substantial exploration and drilling in the area resulted in the discovery and development of many oil and gas fields. Thus, bidders on new leases in the offshore Louisiana area had production history and geologic control data available to them.
In contrast to the offshore Louisiana area, the MAFLA offshore area was not a developed area immediately prior to the taxable years in issue. The first offshore lease sale in the MAFLA offshore area occurred on December 20, 1973. Prior to that time there had been no opportunity to drill any wells in the area.
All of the leases at issue but West Delta 109, which was obtained from the State of Louisiana, were leased from the Minerals Management Service, which is a Federal agency that administers the granting, development, operation, and surrender of oil and gas leases granted by the United States of America. More particularly, the Minerals Management Service is responsible for leasing and for management of operations offshore in the Gulf of Mexico. When the Minerals Management Service offered a list of outer continental shelf blocks that were available for leasing, Gulf assigned the block list to the geophysical section of the company. The geophysical section then prepared a structure map showing the potential deposits that might be contained in the block. In the offshore Louisiana area, it was often possible to use a nearby producing field as an analogue by which Gulf could readily determine the probability of producible oil or gas. In the MAFLA offshore area, it was generally necessary for Gulf to look onshore in order to find analogues, which could be used to determine the potential mineral deposits in the block offered for lease. The structure map of potential deposits was turned over to the geological section of the company, which estimated the potential mineral reserves of each of the potential deposits.
To determine how much it would bid for an offshore lease, Gulf started with the basic geologic evaluation, which would allow the estimation of the amount of oil or gas present in the block of land to be leased. Gulf then estimated potential costs for drilling exploratory wells, drilling and completing development wells, and placing the lease into production. Gulf developed a series of geological maps which were turned over to the reservoir engineers for a recommendation as to the bid Gulf should pay for the block in light of the rate of return on investment that Gulf required. The requisite rate of return varied according to the risk of the prospect. The single most important factor in determining how much to bid for an offshore lease was the geologic assessment of risk. For example, for two potential 100 million barrel prospects, Gulf might be willing to pay $1 million for one which has a low degree of risk and $50 million for the other which has a higher degree of risk. Risk was primarily determined by Gulf's geologists. The final calculation of the amount of Gulf's bid was predicated on an assessment of that risk in light of the data it had accumulated.
The outer continental shelf leases covered only a portion of the Gulf of Mexico and are numbered using the prefix ‘OCS-G.‘ Additional leases were available from the State of Louisiana under the same procedures as the outer continental shelf leases. Gulf made a geologic evaluation to determine the potential mineral deposits present and then submitted a bid to the State of Louisiana.
Gulf acquired undivided interests in 23 oil and gas leases located in the offshore Louisiana area and in the MAFLA offshore area, covering the indicated blocks in the designated offshore areas as of the specified effective dates:
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