'Unbundling' regulation on royalties frustrates oil and gas industry

James Fenton
The Daily Times

The new process is called “Unbundling Cost Allocations” and it is overseen by the Office of Natural Resources Revenue, or ONRR, which is part of the U.S. Department of the Interior. The new rules seek to clarify what costs can be deducted before calculating the 12.5 percent in royalties that are paid to the federal government.

Unbundling requires companies to correctly calculate transportation and processing allowances, some of which are deductible, to arrive at royalty rates they pay the government.

Dugan Production Corp. Vice President John Alexander said that the regulation is overly burdensome and costly.

“It’s very complex to calculate the amount of royalties you owe under this regulation,” Alexander said. “It’s hard, especially for small operators like ourselves. We have to hire experts and pay lawyers to help us sort it out.”

Patrick Etchart, an Office of Natural Resources Revenue spokesman, said that for the last two years, the agency has analyzed operations at select gas processing plants to understand current technology and better determine which costs on services are acceptable deductions.

So far, the ONRR has released new guidance procedures for 10 gas companies processing plants in New Mexico to follow when calculating and reporting royalties. They include the Huerfano Mountain Gas Plant, Williams’ Lybrook Plant and, the most recent to be released and posted on the ONRR’s website, Enterprise’s Chaco Gas Plant.

Etchart said the ONRR hopes to complete an evaluation of about 80 percent of the approximately 200 plants that process natural gas produced on federal lands nationwide in the coming years. He said the 80 percent sends a message that any plant could be evaluated in the near future.

“We are required to ensure a fair value for the American taxpayer and American Indians,” Etchart said, regarding the extraction of non-renewable resources from public and tribal lands. “So the last couple years, we’ve reviewed the processing plants to look at what’s allowable and what’s not. We’re just trying to value, per the law, what royalties are due.”

The new guidelines were forumlated as a result of numerous lawsuits where courts ruled that the blanket deductions claimed by gas production and processing companies were excessive, Etchart said.

ONRR’s cooperative partner, the State and Tribal Royalty Audit Committee, also pushed for reform to shore up what it saw as revenue losses related to natural gas processing, Etchart said.

“The gas processing plants bundle all these charges for producers, but only certain charges are allowable deductions,” Etchart said. “They were submitting these charges for the entire bill they got from the processing plants (as deductions). These plants are like a one-stop shop for getting the gas into marketable condition, including boosting the pressure and removing impurities (which aren’t deductible). But it’s the companies who are responsible for getting their product into marketable shape, not the American taxpayer.”

Etchart said that if a company is processing its natural gas at a plant the ONRR has not reviewed yet, the agency will work with the company through its monthly auditing checks.

The ONRR’s series of engineering studies and reviews of plant operations, which were done in an effort to clarify what costs were subject to royalty payments, has given area gas producers added woes during an extended period of low natural gas prices.

Each year, the ONRR reviews companies’ monthly reports from the last three years to ensure the royalty calculations are accurate.

“In 2015, we’re going back to what (producers) reported in 2012 and performing our audits and compliance checks to make sure the companies are paying appropriate royalties,” Etchart said. “There’s a seven-year statute of limitations. If it’s 2015, we can’t go back to 2006 necessarily, but if we start doing an audit on 2012 production and we see there has been misreporting we can go back further if necessary.”

And the royalties add up to a sizable check for energy-producing states.

In 2014, the ONRR distributed $2.2 billion in royalty payments from energy and mineral production revenue to 36 states. New Mexico received around $579 million of that amount last year, the second highest payment of any state in the country except Wyoming.

Alexander, with Dugan Production, said the retroactive nature of the regulation is especially onerous. The Farmington-based company made the effort over the last year to sort out its books to ensure compliance, Alexander said, but the effort has taken a toll.

“When they made it retroactive, that just killed us,” he said. “Imagine, we are having to review more than 1,000 wells for seven years on a monthly basis. It’s mind-boggling.”

Encana spokesman Doug Hock did not comment directly about possible burdens posed by the regulation, but said the oil and gas company has ensured that it is complying with the new rules.

“We haven’t been audited by ONRR,” Hock said in an email. “However, we’ve taken steps internally to ensure we’re in compliance.”

Farmington independent gas company DJ Simmons Inc. is struggling with the new guidelines, which have caused the company more than $100,000 in attorneys fees and added staff time in a deflated market. One of the company’s leases was audited by the ONRR two years ago, which is when John Byrom, DJ Simmons president and CEO, first learned of the new guidelines.

“(The ONRR is) requiring us to go back six years and recalculate our payments based on their new interpretation of the rules, paying interest,” Byrom said. “We’re taking a big hit on the past and in the future and (it) will take a significant amount of our cash reserves to pay them off.”

Byrom said he and other industry leaders met with U.S. Rep. Ben Ray Lujan, D-N.M., last year over the issue, but no legislation has surfaced yet to address the financial hardships these new guidelines pose to the industry, especially smaller companies like Byrom’s.

“We’ve been following the rules, paying royalties on the same formula for years, and all of a sudden they change the rules and hit us with a severe financial impact,” he said. “They say if we don’t get it right they’ll audit us and let us know, but they’re essentially holding the bar and it’s dark and I can’t see it and they say, ‘Jump anyway. We’ll tell you if you miss.’ We’re hit no matter what we do.”

James Fenton is the business editor of The Daily Times. He can be reached at 505-564-4621 and Follow him @fentondt on Twitter.