Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca10-88-02304/USCOURTS-ca10-88-02304-0/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 

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PUBLISH 

FILED 

Uoited States Court of Appeals 

Tenth Circuit 

MAY l '11990 

UNITED STATES COURT OF APPEALS 

FOR THE TENTH CIRCUIT ~OBERT L. HOECK.ER 

THE SHOSHONE INDIAN TRIBE and 

THE ARAPAHOE INDIAN TRIBE, of the 

Wind River Indian Reservation, 

Plaintiffs-Appellees, 

v. 

DONALD P. HODEL, Secretary of the Interior, 

Department of the Interior, 

Defendant-Appell~e, 

ATLANTIC RICHFIELD COMPANY, 

Defendant-Appellant, 

and 

CHEVRON OIL COMPANY; CONTINENTAL OIL 

COMPANY; SHELL OIL COMPANY, 

Defendants. 

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Appeal From the United States District Court 

For the District of Wyoming 

(D.C. No. C81-0131-K) 

Morris R. Massey of Brown & Drew, Casper, Wyoming for DefendantAppellant. 

Roberts. Thompson, III (Sandra Hansen with him on the brief) of 

Whiteing, Thompson & White, Boulder, Colorado and Susan M. 

Williams (Catherine Baker stetson with her on the brief) of 

Gover, Stetson, Williams & West, Albuquerque, New Mexico for 

Plaintiffs-Appellees. 

Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 1
Michael J. Malmquist (Roger J. Marzulla, Assistant Attorney 

General, Robert L. Klarquist of the Department of Justice and 

Thornton Withers Field of the Office of the Solicitor, Department 

of the Interior, Washington, D.C., with him on the brief) for 

Defendant-Appellee. 

Before HOLLOWAY, Chief Judge, MCWILLIAMS, Circuit Judge, and 

BABCOCK,* District Judge. 

BABCOCK, District Judge. 

* Honorable Lewis T. Babcock, United States District Judge for 

the District of Colorado, sitting by designation. 

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Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 2
Atlantic Richfield Company (ARCO) appeals the final partial 

summary judgment entered in favor of the Secretary of the 

Interior (Secretary) and the Shoshone and Arapaho Indian Tribes 

(Tribes). The judgment upheld audit results prepared by the 

Mineral Management Service (MMS) disallowing certain deductions 

claimed by ARCO which had reduced ARCO's royalty payments to the 

Tribes from wet gas (gas which is rich in natural gas liquids) 

produced from leased tribal land. In doing so, ARCO was ordered 

to pay additional royalties of $37,937.20 for 16 sample months 

and to compute and pay additional royalties for 80 remaining 

months in accordance with the MMS audit. We affirm. 

I. Facts 

This action was brought by the Tribes against the Secretary 

and several oil companies that had mineral leases on tribal 

lands. The Tribes, owners in common of the minerals under the 

tribal lands, claimed that the oil companies had underpaid 

royalties due on gas produced and sold from the Wind River Indian 

Reservation. Defendants Chevron Oil Company, Continental Oil 

Company and Shell Oil Company are not involved in this appeal. 

The Secretary applied the "net realization" method to calculate 

the royalties due. That method requires ARCO to pay royalties 

based on the value of the residue gas and liquids after 

processing, minus a processing allowance. 

In response to the complaint and correspondence from the 

Tribes, the MMS, a subdivision of the Department of the Interior, 

initiated an audit of the gas companies' leases with the Tribes, 

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Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 3
including the ARCO leases, to identify any royalty underpayment. 

Before the audit was completed, ARCO, the other defendants and 

the Secretary stipulated that: 

all unresolved issues raised or to be raised by the 

[MMS] in its audits of royalty payments on natural gas 

and liquid products produced from the Wind River Indian 

Reservation leases which are the subject of this action 

shall be determined by this court (the district court] 

without the necessity of intervening administrative 

appeals. 

After reviewing ACRO's comments, conducting an on-site 

inspection of ARCO's River Dome Gas Plant (RDGP) and surveying 

ARCO's previously filed royalty calculations, the MMS determined 

that several of ARCO's claimed cost deductions were improper. 

ARCO does not claim that there was any procedural error by MMS 

nor does ARCO raise any constitutional challenges. Rather, ARCO 

challenges the MMS conclusion that two cost items were 

nondeductible. Both cost items pertain only to the RDGP. First, 

ARCO contends that the MMS audit was wrong in disallowing ARCO's 

deduction for the cost of gas compression required both to 

manufacture and market the gas. Second, ARCO contends that the 

MMS audit was wrong in disallowing ARCO's deduction of a flat 10% 

of its allowable processing deductions to cover administrative 

overhead costs. Instead MMS required ARCO to specify and verify 

those expenses. 

There being no material factual dispute, the controversy was 

submitted to the district court on cross-motions for summary 

judgment. The district judge granted the Tribes' and the 

Secretary's cross-motion and denied ARCO's cross-motion. 

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Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 4
II. standard of Review 

ARCO contends that the district court should have reviewed 

the decision of the MMS de novo. We disagree. 

ARCO and the Secretary stipulated that any MMS audit 

findings which ARCO disputed would be resolved by the district 

court without the need for exhaustive administrative appeals. 

Had the parties proceeded through the administrative process to 

the district court, the district court would have reviewed the 

decision under the standard of review for final administrative 

actions. 5 u.s.c § 706(2) (A). The stipulation, short-cutting 

the administrative process, does not change the standard of 

review. Accordingly, in affirming the determinations of the MMS 

because they were not "arbitrary, capricious, an abuse of 

discretion, or otherwise not in accordance with law," the 

district court applied the correct standard of review. 

That the issue was raised on a motion for summary judgment 

does not alter the standard of review. There being no material 

factual question in dispute, the court correctly addressed the 

questions of law under the administrative standard of review. 

III. Disputed Cost Deductions 

Our inquiry is under the same standard as that of the 

district court. We look to see whether the district court 

concluded correctly that the MMS judgment was not arbitrary, 

capricious, an abuse of discretion or contrary to law. See 

Marathon Oil co. v. United states, 807 F.2d 759, 765 (9th cir. 

1986), cert. denied, 480 U.S. 940 (1987). We also note that the 

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Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 5
interpretation given by MMS to the applicable royalty and 

deduction regulations is entitled to "controlling weight unless 

it is plainly erroneous or inconsistent with the regulation[s]." 

Udall v. Tallman, 380 U.S. 1, 16-17 (1965) (quoting Bowles v. 

Seminole Rock & Sand Co., 325 U.S. 410, 414 (1945)); Wilder v. 

Prokop. 846 F.2d 613, 619 (10th Cir. 1988). This deferential 

treatment to the administrative interpretation is lessened when 

the interpretation is inconsistent with the intent of the 

drafters, the plain language of the regulation or prior 

administrative interpretations. United Trans. Union v. Dole, 797 

F.2d 823, 829 {10th Cir. 1986). 

A. Statutory and Regulatory Provisions 

The Indian Mineral Leasing Act of 1938, 25 u.s.c. § 396 

permits Indian tribes to grant mineral leases on tribal land with 

the permission of the Secretary of the Interior. The Secretary 

is delegated the authority to define the terms of the leases and 

to "make such rules and regulations as may be necessary for the 

purpose of carrying the provisions of [the] section into full 

force and effect. II . . . The Secretary has exercised this 

authority both by drafting provisions in the ARCO leases and 

promulgating regulations. We look to those provisions and 

regulations to determine if the MMS acted arbitrarily, 

capriciously, with abuse of discretion or contrary to law in 

denying ARCO's claimed deductions. 

B. Deduction Credits against Royalty Payments 

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Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 6
( 

ACRO argues that the MMS erred in disallowing deductions for 

the costs associated with its RDGP inlet compressors. ARCO also 

argues that the MMS erred in disallowing a flat 10% of allowable 

processing deductions to cover administrative costs. We address 

each objection individually. 

1. Compression Costs in Manufacturing Allowance 

Lease provision 3(c) provides that ARCO will pay a royalty 

based on the value of gas produced from the leased land. In 

determining the value of the gas produced, ARCO is permitted "a 

reasonable allowance for the cost of manufacture .. " The 

Secretary has also promulgated regulations allowing for such a 

deduction. 30 C.F.R. § 206.106(b) (1987). That regulation also 

provides that "no allowance shall be made for boosting residue 

gas, or other expenses incidental to marketing." Similarly, 

section V(A) of NTL-5, Notice to Lessees and Operators of Federal 

and Indian Onshore Oil and Gas Leases, 42 Fed. Reg. 22610, 22611 

(1977) (NTL-5 Notice), issued by the Secretary to supplement the 

regulation, provides that marketing costs are nondeductible. 

Finally, the U.S. Geological Survey, the predecessor to the 

MMS, provides guidance in determining what ARCO manufacturing 

costs are deductible. 

Allowable investment costs are generally those 

expenditures for fixed assets (including delivery and 

installation costs) that are directly associated with 

the recovery of natural gas liquids. Most investment 

items are generally located within the confines of the 

plant, beginning at the inlet of the plant and ending 

at the tailgate of the plant, and shall be iimited to 

those items which, in the judgment of the Supervisor, 

are an integral part of the extraction process. 

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Geological Survey, Conservation Division Manual, Part 647.7.3(0) 

(May 10, 1974) (COM) • 

. The plain meaning of the above lease provision and 

regulations is to disallow deduction of those expenditures 

related to marketing extracted gas. Consequently, if it was 

reasonable under the lease and applicable regulations for the MMS 

to conclude that the compressor costs were incidental to 

marketing, then MMS did not act arbitrarily, capriciously, with 

abuse of discretion or contrary to law in refusing to allow 

deduction of those costs. 

The inlet compressors at issue are located in the RDGP 

facilities. Deposition testimony of ARCO petroleum engineers 

established that they perform dual functions. First, they 

increase the gas flow pressure within the plant allowing for 

efficient processing of the gas stream, a manufacturing function. 

Second, they increase the gas flow pressure to the level 

necessary to pass through the pipeline and ultimately to the 

purchaser of the gas, a marketing function. 

The MMS audit concluded that the inlet compressor costs were 

nondeductible. Although the compressors serve a manufacturing 

function, the MMS interpreted the regulations as disallowing 

deductions for costs associated with marketing. This is not 

unreasonable. 

First, manufacturing costs are deductible only if the 

Secretary determines that they are an "integral part" of the 

manufacturing process. CDM, Part 647.7.3(0). Thus, that 

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Appellate Case: 88-2304 Document: 010110296300 Date Filed: 05/17/1990 Page: 8
determination is left to the discretion of the Secretary. 

Second, the Secretary's regulation, found at 30 C.F.R. 

§ 206.106(b) (1987), explicitly disallows deductions for costs 

incidental to marketing, as does section V(A) of the NTL-5 

Notice, also issued by the Secretary, and CDM, Part 647.7.3(0). 

The interpretation by the MMS of these regulations does not 

conflict with their plain meaning and there is nothing to 

indicate that it is contrary to the intent of the regulations' 

drafter. 

ARCO argues that the MMS judgment conflicts with prior 

administrative interpretation. Essentially, ARCO contends that 

because it has submitted royalty reports claiming deductions for 

the inlet compressor costs for the past twenty years, and because 

the deductions have never been rejected as improper, the MMS may 

not now change the long-standing rules of the game. 

ARCO is correct that where an administrative agency 

interprets a regulation consistently over a long period of time, 

publicly, and through careful and sound reasoning, modifications 

of the interpretation should be scrutinized by the courts. 

Skidmore v. Smith, 323 U.S. 134, 140 (1944) (thorough, valid 

reasoning and consistency); Udall v. Tallman, 380 U.S. 1, 17-18 

(1965) (public record and discussion). Until now however, ARCO 

royalty reports were never challenged. This administrative 

acquiescence does not, therefore, rise to the level of longstanding policy. 

2. Unverified Costs in Overhead Allowance 

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The Conservation Division manual provides that deductions 

for overhead costs "shall be limited to ten percent of the other 

permitted operating and maintenance costs." CDM, Part 

647.7.J(E) (9). Further, the deductible administrative costs 

"will generally be limited to those items which, in the judgment 

of the Supervisor, are an integral part of the extraction 

process. Such expenditures may be verified by requesting copies 

of the invoices." Id. at 647.J(E). 

The MMS audit concluded that the overhead deduction can be 

as high as ten percent of the other permissible operating and 

maintenance costs, but that the overhead costs required 

verification. ARCO contends that this interpretation is in error 

because ARCO should be permitted to deduct the ten percent 

overhead allowance regardless of its ability to verify the costs. 

As its primary rationale, ARCO argues that for the past twenty 

years it has successfully deducted the ten percent without the 

need to verify costs and that, therefore, there is a long 

standing policy of allowing such deductions. However, as 

discussed above, this does not constitute a long standing policy. 

Furthermore, the MMS interpretation is consistent with the 

regulations. 

Because the judgment of the MMS is not arbitrary., 

capricious, an abuse of discretion or contrary to law, we AFFIRM 

the judgment of the district court. 

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