Case Title: EOG RESOURCES, INC. v. DEPARTMENT OF REVENUE

Citation: 

Docket Number: 

State: wyoming

Court: Wyoming Supreme Court

Date: 2004-03-31T00:00:00Z

Document:
EOG RESOURCES, INC. v. DEPARTMENT OF REVENUE2004 WY 3586 P.3d 1280Case Number: 02-231Decided: 03/31/2004
OCTOBER 
TERM, A.D. 2003

 

                                                                                                            

 

EOG 
RESOURCES, INC., formerly

Enron 
Oil and Gas Corporation, a

Delaware 
corporation,

 

Appellant(Petitioner),

 

v.

 

DEPARTMENT 
OF REVENUE,

State 
of Wyoming,

 

Appellee(Respondent).

 

 

W.R.A.P. 
12.09(b) Certification from the District Court of Sublette 
County

 

 

Representing 
Appellant:

Lawrence 
J. Wolfe and John P. Glode of Holland & Hart, LLP, Cheyenne, Wyoming; Judith 
M. Matlock of Davis, Graham & Stubbs, LLP, Denver, Colorado; Steven P. 
Williams, Assistant General Counsel-North America, EOG Resources, Inc., Denver, 
Colorado.  Argument by Mr. 
Wolfe.

 

Representing 
Appellee:

Patrick 
J. Crank, Wyoming Attorney General; Michael L. Hubbard, Deputy Attorney General; 
Martin L. Hardsocg, Senior Assistant Attorney General.   Argument by Mr. 
Hardsocg.

 

 

Before 
HILL, C.J., and GOLDEN, LEHMAN, KITE, and VOIGT, JJ.

 

 

GOLDEN, 
Justice.

 

[¶1]           
Appellant 
EOG Resources, Inc. (EOG) paid severance and ad valorum tax for severance of 
minerals as part of a financing arrangement known as a volumetric production 
payments (VPP) agreement.1  The Department of Revenue (Department) 
reviewed the several transactions comprising the VPP agreement and determined 
that an arm's length sale of minerals had occurred.  It calculated a valuation based on 
contract pricing and assessed additional tax and interest.  The Board of Equalization (Board) 
affirmed the Department's actions although it limited the interest 
assessment.  EOG appealed on the 
basis that the entirety of the VPP agreement constituted a financing agreement 
warranting treatment as a non-arm's length sale.  

 

[¶2]           
We 
affirm the Board's order.

 

ISSUES

 

[¶3]           
EOG 
presents this statement of the issues for our review:

 

A.  Under 
Wyo. Stat. § 39-14-203(b)(v), only gas "sold" in a bona fide arm's length sale 
at or prior to the point of valuation is valued on the basis of such a 
sale.  Cactus financed EOG's Wyoming 
oil and gas development by advancing EOG $326,775,000 in return for an ownership 
interest in, and the production from, a portion of EOG's Wyoming reserves.  To repay this advance, EOG exchanged gas 
in Colorado and Texas for Cactus's Wyoming oil, gas, and condensate 
production.  Did the Board err in 
concluding that the transfer of title to Cactus's production in Wyoming to EOG 
was an "arm's length sale" subject to valuation under Section 39-14-203(b)(v)? 

 

B.  Article 
15, Section 11 of the Wyoming Constitution requires a uniform tax valuation for 
Wyoming oil and gas production.  By 
treating the exchange of Cactus's Wyoming oil, gas, and condensate production 
for EOG's oil, gas and condensate in Texas and Colorado as an arm's length sale, 
the Board disregarded the full terms of the financing transaction between Cactus 
and EOG.  Instead, the Board valued 
Cactus's Wyoming gas on the basis of index prices in distant markets without 
accounting for EOG's repayment obligations to Cactus.  Under Article 15, Section 11 is it 
proper to value Wyoming oil, gas and condensate production on the basis of the 
index value of gas in distant markets? 

 

C.  Under 
§ 39-14-203(b)(vi) the Department of Revenue is required to utilize one of four 
prescribed alternative valuation methods when the first arm's length sale of 
Wyoming oil and gas production occurs downstream of a brightline point of 
valuation defined for gas in §§ 39-14-203(b)(iv) as the outlet of the initial 
dehydrator.  The delivery of 
Cactus's Wyoming gas production to EOG occurred downstream of this point.  EOG therefore used the comparable value 
method to value its gas production.  
Was the Department required to apply one of the alternative valuation 
methods found in § 39-14-203(b)(vi)? 

 

The 
Department presents the following statement of the issues:

 

A.  Did 
the Board of Equalization correctly affirm the Department's valuation of EOG's 
production of "volumetric production payment" gas, which was conveyed 
arms-length by Cactus to EOG at the wellhead for valuable consideration, 
pursuant to Wyo. Stat. § 39-2-208(c)? 

 

B.  Did 
owner Cactus's conveyance of the Wyoming gas at the wellhead to EOG through an 
exchange for equivalent gas at locations in Texas and Colorado, which was 
ascribed a value equal to the index prices at the points in Texas and Colorado, 
and which was actually sold for the index prices at the locations in Texas and 
Colorado, constitute a taxable transaction pursuant to Wyo. Stat. § 39-2-208(c)? 

 

C.  May 
Cactus convey arms-length full title and ownership of extracted natural gas for 
valuable consideration at the wellhead as part of a purported financing 
transaction and thereby avoid tax liability? 

 

D.  Assuming 
Cactus conveyed gas arms-length to EOG for valuable consideration as part of a 
purported financing arrangement ("volumetric production payment"), is the sale 
of Wyoming gas within said financing arrangement exempt from severance and ad 
valorem taxation pursuant to WYO. STAT. § 39-2-208? 

E.  Was 
the Department of Revenue authorized to identify as the taxable value an 
arms-length sale for Wyoming gas at the wellhead pursuant to Wyo. Stat. § 
39-2-208(c), in which the parties attributed a value to the gas equal to index 
prices from other localities, which were on the average higher than the sales 
prices of other Wyoming gas? 

 

F.  Did 
the Board of Equalization correctly reject EOG's efforts to raise untimely 
claims and issues regarding the point of valuation and the presence of 
dehydrators? 

 

G.  Did 
the Board of Equalization correctly conclude that EOG's untimely claim and 
argument that the presence of dehydrators inches or feet before the custody 
transfer meters within the same enclosure ("combo unit") were legally and 
factually inconsequential and did not render improper the application of Wyo. 
Stat. § 39-2-208(c)? 

  

FACTS

 

[¶4]           
EOG 
and its predecessors in interest have owned and operated wells in Lincoln and 
Sublette Counties since the 1950s and produce primarily from the LaBarge 
Platform and the Moxa Arch formations.  
In 1992, EOG owned and operated over 800 wells in Sublette and Lincoln 
Counties.  EOG had a significant 
lease position and a huge reserve base but, because of low gas prices, EOG was 
unable to finance additional development of the reserves.  In 1992, in order to finance the 
development of its oil and gas reserves, EOG made the decision to enter into a 
volumetric production payment transaction. 

 

[¶5]           
A 
volumetric production payment is a common form of an oil and gas financing 
transaction that has been used for decades. A producer sells its production for 
a limited duration in exchange for capital funds.  The buyer receives a share of oil and 
gas produced for a limited time, free and clear of any of the costs of 
production, and its production payment interest is a real property interest of 
limited duration.  Because the buyer 
owns the production, it has protection from the bankruptcy of the producer if 
the conveyance does not create a mortgage. Generally, production payment 
transactions consist of three documents, namely, a purchase and sales agreement, 
a conveyance, and a production and delivery agreement.  

 

[¶6]           
In 
this case, the VPP transaction was entered into between EOG and Cactus 
Hydrocarbon 1992-A Limited Partnership II (Cactus) on September 25, 1992.  The VPP transaction contained all three 
documents referenced above as well as another agreement providing for an 
exchange (Exchange Agreement). Under the purchase and sales agreement, Cactus 
gave EOG $326,775,000 in exchange for a production payment interest in reserves 
in the ground.    EOG 
operated the properties subject to the VPP agreement and produced the oil and 
gas, including the oil and gas now owned by Cactus.  Although Cactus' ownership made it 
responsible for reporting and paying taxes on its share of product, the VPP 
agreement provided that EOG would assume all responsibility for reporting and 
paying all applicable taxes. 

 

[¶7]           
Of 
particular significance to this case is that the VPP transaction also included 
an Exchange Agreement where Cactus delivered the minerals back to EOG and, 
simultaneously, EOG agreed to deliver gas to Cactus at four locations in 
Colorado and Texas.  The VPP 
documents specified that delivery from Cactus back to EOG was accomplished at 
meters close to the well site.  This 
variation of the standard VPP agreement raised questions whether this exchange 
of product altered the VPP agreement's nature from a standard financing 
arrangement to an exchange on terms equivalent to cash, i.e., a sale.  The amounts of gas delivered at the 
Colorado and Texas downstream locations were equivalent on an MMBTU2 basis to the volumes of oil, gas 
and condensate delivered by Cactus to EOG at the Wyoming locations.  More facts relating to the Exchange 
Agreement are provided below in the discussion section.

 

[¶8]           
Cactus 
executed a fifth document simultaneously with the Exchange Agreement.  The fifth document, however, was between 
Cactus and a third party, Enron Gas Marketing, Inc. (EGM).   Under the fifth document (EGM 
Purchase Agreement), Cactus sold the Colorado and Texas gas to EGM and priced it 
based on index pricing specific to those locations.  The Board found that index pricing in 
those Colorado and Texas locations was generally higher than for Wyoming. 

 

[¶9]           
The 
existence of this Exchange Agreement in conjunction with the EGM Purchase 
Agreement caused the Department to determine that this VPP transaction was 
something more than a financing arrangement.  The Department's review of all five 
documents led to its conclusion that this Exchange Agreement resulted in an 
arm's length sale of natural gas3 and based the fair market value on 
the index pricing referenced in the agreement.  The Department also determined that the 
sale occurred at a point of valuation that required application of § 
39-2-208(c).4  EOG had reported a non-arm's length 
exchange of natural gas at the well head and applied an alternative tax method 
as provided in § 39-2-208(d).5  The Department assessed additional 
severance tax liability in the amount of $1,723,952.02 and additional interest 
in the amount of $1,187,608.  The 
increased ad valorem taxable value was calculated and certified to Sublette and 
Lincoln Counties for application of mill levies. 

 

[¶10]      Cactus, 
as owner of the oil and gas, was responsible for tax liabilities; however, the 
VPP transaction provided that EOG would report and pay all taxes, and it was EOG 
that appealed the Department's assessment to the Board.  At a hearing before the Board, the 
Department contended that a sale had occurred at the meters and the valuation 
should be based on the fair market value of a bona fide arm's-length sale as 
provided by § 39-2-208(c).  EOG 
contended that an exchange, not a sale, had occurred at the wellhead; however, 
if the Board determined that a sale had occurred at meters, EOG then contended 
that the Board must find that point was downstream and the valuation method 
would be determined by § 39-2-208(d). 

 

[¶11]      The 
Board held that a sale at the meters had occurred, and although EOG alleged that 
the correct valuation should have been pursuant to § 39-2-208(d), the Board 
ruled otherwise because EOG had failed to raise the issue during the audit and 
it was untimely to now raise the issue at hearing.  The Board further found that the 
Department's determination should be upheld because the distance of the meters 
from the wellhead was too insignificant to allow downstream valuation.   The Board did find, however, that 
EOG should not be assessed interest for the entire period.  Other than that change, the Board 
affirmed the Department in all respects.  
EOG now appeals the Board's decision to this Court.  

 

DISCUSSION

 

 

[¶12]      
Considerable 
deference is accorded to the findings of fact of the agency, and this Court does 
not disturb them unless they are contrary to the overwhelming weight of the 
evidence.  Amoco Production Co. 
v. Wyoming State Bd. of Equalization, 12 P.3d 668, 671 (Wyo. 2000).  An agency's conclusions of law can be 
affirmed only if they are in accord with the law.  Id. at 672.  Our function is to correct any error 
that an agency makes in its interpretation or application of the law.  In addition, during our judicial review, 
we will invalidate agency findings or actions made without authority.  Id.  

 

 

[¶13]      Natural 
gas is valued for taxation at its fair market value after the production process 
is completed.  § 
39-2-208(a).  The production 
process for natural gas is completed "after extracting from the well, gathering, 
separating, injecting and any other activity which occurs before the outlet 
of the initial dehydrator."  § 
39-2-208(b)(ii) (emphasis added).  
If natural gas is sold to a third party at or prior to this point of 
valuation, then the fair market value shall be the value established by bona 
fide arm's-length transaction. § 39-2-208(c).  If natural gas is sold after that 
point, then an alternative method of valuation listed in the statute 
applies.  § 39-2-208(d).  The primary question for us is 
whether a sale occurred at all.  The 
statute defines a bona fide arm's-length sale as "a transaction in cash or terms 
equivalent . . . after reasonable exposure in a competitive market between a 
willing, well-informed and prudent buyer and seller with adverse economic 
interests."  Wyo. Stat. Ann. § 
39-14-201(a)(ii) (LexisNexis 2003).  
As the analysis that follows shows, we do find that a sale occurred and 
that sale occurred after the point of valuation.     

 

[¶14]      In 
its first issue, EOG contends that the Department erred in determining that the 
VPP transaction was an arm's-length sale and not a financing arrangement subject 
to lower valuation because the Department wrongly concluded that the exchange 
was a sale on terms equivalent to cash.  
EOG disagrees that the exchange of product that occurred was a critical 
variation.  Although EOG contends 
that the exchange was a production payment, our review causes us to agree with 
the Department's conclusion that a sale occurred.

 

[¶15]      Generally, 
a VPP transaction provides that in exchange for a large infusion of capital 
upfront, a producer conveys ownership of production to the buyer for a limited 
duration.  The buyer benefits 
primarily by gaining reliability in delivery and the buyer's ownership of the 
production protects it from a producer's bankruptcy.  For federal income tax purposes, the 
seller is seen as borrowing money and mortgaging the minerals as security for 
the loan.  The VPP financing 
transaction is often available to a producer when bank or mezzanine financing is 
not.  Additional benefits gained by 
a producer are that the VPP is treated as a sale of revenue rather than debt 
and, because the producer retains control of operations, after the agreed upon 
production is delivered the producer receives still more capital from production 
after the VPP ends.  

 

[¶16]      Based 
on this description it is easy to see that the parties did enter into a 
financing transaction when Cactus exchanged over $326,000,000 for production 
ownership.  Under this standard 
arrangement, the Department, the Board and EOG all correctly determined that § 
39-2-208(d) would have applied for valuation purposes.  However, the parties did not limit this 
transaction to that of a standard VPP arrangement, whereby Cactus received 
Wyoming production in exchange for upfront cash to EOG.  

 

[¶17]      The 
parties entered into a second agreement, the Exchange Agreement, entitling 
Cactus to receive higher priced Texas and Colorado production as repayment for 
its upfront cash to EOG.  At the 
custody transfer meter, the minerals owned by Cactus were delivered by Cactus 
back to EOG.  Simultaneously, EOG 
was required to deliver an equivalent amount of gas to Cactus at four locations 
in Colorado and Texas.  The Exchange 
Agreement provided that if EOG failed to deliver product to Cactus in Colorado 
and Texas, EOG would pay the equivalent amount in cash.  The value would be determined by index 
pricing relevant to those markets.  
Simultaneously to the Exchange Agreement, Cactus, which is composed of 
investors, sold the product received in Colorado and Texas to a third party 
(EGM) and valued that product by index pricing.  The Cactus/EGM transaction was entered 
into on September 25, 1992, referenced the VPP agreement and required EGM to 
pursue EOG in the event of any default.  
The VPP agreement was transferred to another group (Cactus III) and 
terminated in 1999. 

 

[¶18]      EOG 
reported and paid taxes pursuant to § 39-2-208(d) and in reliance upon a memo 
sent by the Department instructing all oil and gas producers to use the 
comparable value method to value the sales of production that were not sold by 
arm's length sales at the wellhead.  
In 1997, the Department began an audit of EOG's Lincoln and Sublette 
County production.  Unfamiliar with 
a VPP as a form of financing, the representatives of the Department and the 
Attorney General's office met with EOG's representatives in Houston, Texas, and 
reviewed the VPP transaction documents.  
These documents revealed that after Cactus acquired title to EOG oil and 
gas production in exchange for cash, Cactus and EOG again exchanged product that 
Cactus sold to a third party, EGM.  

 

[¶19]      Based 
upon information from these documents, the Department determined that it must 
view the entire transaction as an arm's-length sale and based valuation on the 
index pricing referenced in the Cactus/EGM transaction where Cactus 
simultaneously resold the Texas and Colorado product to a third party for 
profit.  Under this arrangement, 
Cactus was repaid faster by EOG, never had to take possession of any product, 
and its risk was further reduced by a clause in the exchange agreement that 
provided that if EOG failed to deliver the Texas and Colorado product, EOG would 
make a cash payment to Cactus in accordance with regional index pricing.  That same regional index pricing 
controlled the sale between Cactus and EGM.  

 

[¶20]      EOG 
defends the Exchange Agreement transaction as the agreed upon repayment method 
required under the refinancing arrangement and argues vigorously that the 
exchange was not a bona fide arm's-length transaction as defined by statute,6 and therefore the Department was 
not permitted to base the valuation upon index pricing.  Viewing the VPP transaction in its 
entirety, we agree with the Department that the VPP transaction was a variation 
of the standard financing arrangement that was not simply intended to provide 
financing, but was intended ultimately as a sale of product.  

 

[¶21]      Under 
the statute, valuation is determined by the type of transaction associated with 
the severance. § 39-2-208(c), (d).  
By this language, the legislature has directed that the Department and 
the Board view this transaction in its entirety.  That review revealed that this 
transaction intended something beyond mere financing.  A sale was intended based upon the 
"index pricing" referenced in the Exchange Agreement and the Department properly 
relied upon that index pricing as the parties' valuation of the product's fair 
market value.  Our review agrees 
with this assessment of the transaction and neither those entities nor this 
Court is permitted to ignore legislative intent because the contracting parties 
designated the transaction as a financing arrangement.  Producing natural gas by means of 
complex financing, brokering, and sales agreements may well warrant different 
valuation treatment; however, the present statutory scheme does not permit it 
and changing that scheme is a matter for the legislature and beyond the purview 
of this Court.

 

Constitutional 
Requirement of Uniformity

 

[¶22]      EOG's 
second issue disputes the Department's use of index pricing from the distant 
regions of Colorado and Texas without accounting for its repayment obligations 
to Cactus.  The Department tells us 
that it routinely uses index pricing whenever an agreement references index 
pricing to determine contract price.  
The Board also found it routine and EOG fails to explain why this method 
is inappropriate for a sales transaction.  
We find that EOG's argument is relevant only if we had determined that a 
financing, rather than a sales, agreement existed.  Our decision is otherwise, and we do not 
further consider the issue.

 

 

Point 
of Valuation

 

[¶23]      Finally, 
EOG complains that if a sale did occur, it was not a sale at or prior to the 
point of valuation and the proper method of valuation was under § 
39-2-208(d).  The Board 
found:

 

In 
its Motion for Reconsideration, Petitioner indulged in a hyper-technical 
argument that if the Department's position was correct that an arm's length sale 
took place at the custody transfer meter under the VPP documents, then the 
Department should have used an alternative valuation method under the statute 
because technically the gas sold a few feet away from the outlet of the 
dehydrator which is downstream 
from the statutory point of valuation.  
The Board finds this argument to be both breathtakingly ingenious and 
nonsensical at the same time.  The 
reason why the Wyoming Legislature deemed it necessary to establish a point of 
valuation was because it was important to separate upstream production costs 
from downstream transportation costs, the latter being deductible from the gross 
value received by the producer at the wellhead.  Many times this becomes important in gas 
fields where the wellheads, dehydrators and custody transfer meters are located 
miles apart.  When the custody 
transfer meter and the outlet of the dehydrator are located virtually 
side-by-side as they are in this case, the distance is of no significance 
whatsoever.  The Board found 
Petitioner's argument to be irrelevant at the hearing and after further 
reviewing the record, we find it to be irrelevant still.

 

EOG 
contends that the Board has no evidence supporting its legislative intent 
assertion, the point of valuation defined in § 39-2-208(b) is unambiguous and 
the definition establishes a legislative intent to draw a bright line as to when 
the Department may use arm's-length sales at or before this point and when it 
must resort to alternative valuation methods.

 

[¶24]      The 
Department and the Board determined that a sale from Cactus back to EOG occurred 
after the outlet of the initial dehydrator at the custody transfer meter.  Finding that the transfer occurred at 
the meter factored into the overall assessment that the production payment was a 
sale and not an exchange.  Despite 
the statutory language indicating that this distinction would determine whether 
§ 208(c) or (d) applied, the close physical proximity of the two points prompted 
the Board to deduce that the legislature intended for § 208(c) to apply.  Legislative intent, however, must be 
derived from the plain language of the statute unless ambiguity exists.  Parker 
Land and Cattle Co. v. Wyoming Game and Fish Comm'n, 
845 P.2d 1040, 1042-43 (Wyo. 1993).   In this case, the statutory language 
unambiguously distinguishes between these two points with no reference to 
physical proximity.  This provision, 
however, must be read as part of the whole statute.  Id. 
at 
1043-44.  If § 208(d) applies, then 
the fair market value is the arms length sales price less processing and 
transportation fees.  The Department 
advises us that finding error is pointless because the comparative value 
methodology will apply and no significant difference in valuation will result 
for EOG.    The Board also 
concluded that because the custody transfer meters were next to the outlet, it 
was immaterial which valuation method was applied.  

 

[¶25]      EOG 
ignores this de minimis argument, contends that the statute's plain language 
must be enforced and requests that this court reverse and remand with 
instructions to determine which, if any, of the "sales" took place at or before 
the point of valuation.  Based upon 
this response, we believe that although EOG is correct in its assertion that the 
Department did not correctly determine the point of valuation under § 208(b), we 
will uphold the Board's decision under the de minimis 
doctrine.  Without any indication that the distance 
of the meter from the outlet measurably increased processing and transportation 
and any other costs dealt with by the comparative value method of § 208(d), 
a reversal and remand for recalculation is unnecessary.   

 

 

CONCLUSION

 

[¶26]      A 
standard volumetric production payment is a financing arrangement; however, this 
VPP transaction included a series of exchanges for terms equivalent to cash 
based upon index pricing that produced an arms length sale.  The point of valuation for the sale did 
require application of § 208(d); however, that error was not brought to the 
Department or Board's attention until well after the audit.  At that point, the Board properly 
determined that the error was de minimis 
and 
it was not required to remand for a recalculation.  The order of the Board is affirmed. 

 

     
FOOTNOTES

 

1The 
statute governing this transaction was Wyo. Stat. Ann. § 39-2-208 (Michie 
1997).  That statute has been 
revised and renumbered and is now found at Wyo. Stat. Ann. § 39-14-203 
(LexisNexis 2003).

 

2EOG 
explains that MMBTUs are a measure of the heating content or energy available in 
a fuel and constitute one million British Thermal Units.  Gas is measured in MMBTUs but oil and 
condensate are normally measured in barrels. 

 

3The 
Department audit did not dispute the valuation method of any other type of 
mineral and none were at issue at the Board 
hearing.

 

4Wyo. Stat. Ann. § 39-2-208(c) (Michie 1997) 
provides:

If 
[natural gas is] sold to a third party, or processed or transported by a third 
party at or prior to the point of valuation provided in subsection (b) of this 
section, the fair cash market value shall be the value established by bona fide 
arms-length transaction.

 

5Wyo. Stat. Ann. § 39-2-208(d) (Michie 1997) 
provides:

In 
the event the [natural gas] is not sold at or prior to the point of valuation by 
bona fide arms-length sale . . . [t]he department shall determine the fair cash 
market value by application of one (1) of the following 
methods:

(i) 
Comparable sales 
-- . . .

(ii) Comparable value -- . . .

(iii) Netback -- . . .

(iv) Proportionate profits -- . . . .

 

6Wyo. Stat. Ann. § 39-14-201(a)(ii) states:   "Bona fide arm's-length sale' 
means a transaction in cash or terms equivalent to cash for specified property 
rights after reasonable exposure in a competitive market between a willing, well 
informed and prudent buyer and seller with adverse economic interests and 
assuming neither party is acting under undue compulsion or 
duress[.]"