Independent Petroleum Ass'n of America v. Babbitt, s. 95-5210

Citation92 F.3d 1248
Decision Date21 November 1996
Docket NumberNos. 95-5210,95-5245,s. 95-5210
Parties, 135 Oil & Gas Rep. 1 INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA, et al., Appellants, v. Bruce BABBITT, et al., Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (District of Columbia)

Page 1248

92 F.3d 1248
320 U.S.App.D.C. 107, 135 Oil & Gas Rep. 1
Bruce BABBITT, et al., Appellees.
Nos. 95-5210, 95-5245.
United States Court of Appeals,
District of Columbia Circuit.
Argued April 16, 1996.
Decided Aug. 27, 1996.
Rehearing Denied Nov. 21, 1996. *

Page 1250

[320 U.S.App.D.C. 109] Appeals from the United States District Court for the District of Columbia (No. 93cv02544) (No. 94cv02123).

L. Poe Leggette, argued the causes for appellants, with whom, E. Edward Bruce, Washington, DC, was on the briefs.

William B. Lazarus, United States Department of Justice, argued the cause for appellees, with whom Peter D. Coppelman, Acting Assistant Attorney General, and Robert L. Klarquist, Washington, DC, were on the brief.

Lawrence G. McBride, Washington, DC, was on the brief for amicus curiae Interstate Natural Gas Association of America et al., in support of appellants.

Frederick C. Whitrock, Baton Rouge, LA, was on the brief for amicus curiae State of Louisiana in support of the appellees.

Jan Unna, Special Assistant Attorney General, was on the brief for amicus curiae State of New Mexico.

Jill E. Grant, Washington, DC, entered an appearance for amicus curiae Jicarilla Apache Tribe.

Before: BUCKLEY, SENTELLE and ROGERS, Circuit Judges.

Opinion for the court filed by Circuit Judge SENTELLE.

Separate dissenting opinion filed by Circuit Judge ROGERS.

SENTELLE, Circuit Judge:

Appellants, an oil and gas producer and a petroleum industry trade association, challenge as arbitrary and capricious and inconsistent with applicable law a Department of the Interior ("DOI") decision to collect royalties and interest charges from the gas producer appellant on a settlement payment made to a lessee of a natural gas well on allotted Indian lands in exchange for a compromise of accrued and prospective take-or-pay liabilities under an outstanding contract. The gas producer appellant also claims that, even if the DOI decision to collect royalties was valid, the government is barred by a statute of limitations from collecting royalties and interest on the specific take-or-pay settlement payment at issue in this case. The District Court granted summary judgment for the government on both issues. Because we conclude that DOI impermissibly departed from its established practices in attempting to collect royalties on the settlement

Page 1251

[320 U.S.App.D.C. 110] payment, we reverse the District Court and hold that the gas producer appellant cannot be required to pay any royalties on the settlement payment. We accordingly find it unnecessary to consider the statute of limitations issue.

I. Background: The Natural Gas Industry and Royalties on "Take-or-Pay" Payments and Settlements

DOI, through its Minerals Management Service ("MMS"), issues and administers leases for offshore oil and gas production under the Outer Continental Shelf Lands Act ("OCSLA"), 43 U.S.C. § 1331 et seq., for onshore production on federal lands under the Mineral Leasing Act ("MLA"), 30 U.S.C. § 181 et seq., and the Mineral Leasing Act for Acquired Lands, 30 U.S.C. § 351 et seq., and for production on Indian tribal and allotted lands under 25 U.S.C. §§ 396, 396a-396g. Certain DOI leases include royalty provisions which calculate royalties as a percentage of the "amount or value of the production saved, removed, or sold" by the lessee. See, e.g., OCSLA, 43 U.S.C. § 1337(a)(1)(A), (C) & (G); MLA, 30 U.S.C. § 226(b) & k(1)(2); see also 25 C.F.R. § 211.13 (1995) (tribal leases); 25 C.F.R. § 212.16 (1995) (Indian allotted land leases). This case involves a dispute over whether lump-sum payments made by gas pipelines to lessees to settle large "take-or-pay" liabilities accrued under long-term gas purchase contracts are properly subject to royalties.

This controversy arises from a fundamental change in the natural gas industry over the past several years. See generally United Distribution Cos. v. FERC, 88 F.3d 1105 (D.C.Cir.1996) (per curiam) (discussing the line of cases beginning with Associated Gas Distributors v. FERC, 824 F.2d 981 (D.C.Cir.1987), cert. denied, 485 U.S. 1006, 108 S.Ct. 1468, 99 L.Ed.2d 698 (1988) ("AGD I"), and including American Gas Ass'n v. FERC, 888 F.2d 136 (D.C.Cir.1989), cert. denied sub nom. FERC v. Public Util. Comm'n, 498 U.S. 952, 111 S.Ct. 373, 112 L.Ed.2d 335 (1990) ("AGA I"), and American Gas Ass'n v. FERC, 912 F.2d 1496 (D.C.Cir.1990), cert. denied sub nom. City of Willcox v. FERC, 498 U.S. 1084, 111 S.Ct. 957, 112 L.Ed.2d 1044 (1991) ("AGA II")). Previously, natural gas pipelines acted as gas merchants, purchasing gas at the wellhead, transporting it, and reselling it to local distribution companies ("LDCs") and large end users. In the 1980s, after concluding that this system resulted in various market distortions and inefficiencies, the Federal Energy Regulatory Commission ("FERC") began the lengthy process of transforming pipelines from gas merchants to common carriers of gas. Along the way, Congress completed the deregulation of wellhead gas prices through the Natural Gas Wellhead Decontrol Act of 1989 ("Decontrol Act"), Pub.L. No. 101-60, 103 Stat. 157. Under regulated wellhead pricing, the pipelines, consistent with FERC policy, had entered into long-term, fixed price wellhead purchase contracts. After wellhead price deregulation the market price for gas dipped well below the long-term contract prices pipelines were committed to pay. AGD I, 824 F.2d at 995-96.

Unfortunately for the pipelines, the wellhead contracts usually contained take-or-pay provisions, which required the pipeline to pay for as much as seventy-five percent of the contracted-for gas even if it did not take the gas. Id. at 996. (Often, the pipeline could credit these payments toward "make-up gas," gas taken at a later date. See Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 1159, 1164 (5th Cir.1988) ("Diamond Shamrock")). Because the pipelines could not rely on corresponding long-term sales contracts with their customers (FERC had allowed those customers to abrogate such contracts with pipelines, see Wisconsin Gas Co. v. FERC, 770 F.2d 1144, 1152 (D.C.Cir.1985), cert. denied, 476 U.S. 1114, 106 S.Ct. 1968, 90 L.Ed.2d 653 (1986)), they soon found themselves headed for financial ruin as their customers switched to cheaper supply sources. FERC experimented with several relief mechanisms, see United Distribution Cos., 88 F.3d at 1124-27; Baltimore Gas & Elec. Co. v. FERC, 26 F.3d 1129, 1132-33 (D.C.Cir.1994); but the major resolution of the take-or-pay liabilities occurred through settlements between pipelines and their suppliers. See AGA II, 912 F.2d at 1508-09 (upholding FERC's decision to allow private negotiations, under incentives structured by

Page 1252

[320 U.S.App.D.C. 111] the Commission, to remedy the industry's take-or-pay problems). The pipelines could then pass on at least some of the costs of these settlements to their customers. See Order No. 528, Mechanism for Passthrough of Pipeline Take-or-Pay Buyout and Buydown Costs, 53 FERC p 61,163 (1990), order on reh'g, 54 FERC p 61,095, reh'g denied, 55 FERC p 61,372 (1991).

The take-or-pay settlements were of two types--"buydowns" and "buyouts." In a buydown, the pipeline pays a cash lump sum to the producer in exchange for contract amendments (or a new contract) providing for continued sale of the contracted-for gas at reduced prices. In a buyout, the pipeline pays a cash lump sum in exchange for release of the pipeline from the gas purchase contract. The producer is then free to sell the gas to someone else. Some contract settlements included both partial buydowns and partial buyouts. In some cases, the settlement payments (or portions thereof) could be recouped through future gas purchases in which the payments would be credited toward the purchase price of gas. See, e.g., Blackwood & Nichols Co., Ltd., MMS-88-0008-O&G (Apr. 20, 1989), 10 Gower Fed. Serv., Royalty Valuation and Management at 2 ("Blackwood & Nichols Co.") (construing a settlement agreement containing both a recoupable and a nonrecoupable payment). Both types of contracts also often include a settlement of existing liability for previously incurred take-or-pay obligation.

As DOI lessees were among the producers entering settlement agreements, MMS began to address the royalty implications of take-or-pay payments and contract settlement payments on lessees' liabilities. As we noted earlier, the statutes governing the leases require that they contain a royalty clause contemplating royalties to be paid on a set percentage of the "amount or value of the production saved, removed, or sold" by the lessee. See, e.g., OCSLA, 43 U.S.C. § 1337(a)(1)(A); MLA, 30 U.S.C. § 226(b); see also 25 C.F.R. § 211.13 (1995) (tribal leases); 25 C.F.R. § 212.16 (1995) (Indian allotted land leases). MMS' general rule on royalties, known as the "gross proceeds rule," provides that "under no circumstances shall the value of production for royalty purposes be less than the gross proceeds accruing to the lessee for lease production." 30 C.F.R. § 206.152(h) (1995) (emphasis added). 1 30 C.F.R. § 206.151 (1995) defines "gross proceeds" as "the total monies and other consideration accruing to an oil and gas lessee for the disposition of [gas]." The underlying issue leading to the present case is whether gas contract settlement payments are included in "gross proceeds." In a series of administrative decisions, MMS determined that royalties are due on both take-or-pay payments and payments for gas contract settlements. Before these decisions reached the stage of judicial review, DOI issued rules in January 1988 adopting a broad definition of "gross proceeds":

"Gross proceeds" (for royalty payment purposes) means the total monies and other consideration accruing to an oil and gas lessee for the disposition of ... gas.... Gross proceeds, as applied to gas, also...

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