Case Name: INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA, et al., Appellants, v. Bruce BABBITT, et al., Appellees
Court: United States Court of Appeals for the District of Columbia Circuit
Jurisdiction: District of Columbia
Decision Date: 1996-08-27
Citations: 320 U.S. App. D.C. 107
Docket Number: Nos. 95-5210, 95-5245
Parties: INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA, et al., Appellants, v. Bruce BABBITT, et al., Appellees.
Judges: Before: BUCKLEY, SENTELLE and ROGERS, Circuit Judges.
Reporter: United States Court of Appeals for the District of Columbia Circuit
Volume: 320
Pages: 107–129

Head Matter:
92 F.3d 1248
INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA, et al., Appellants, v. 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.
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.

Opinion:
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 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(l)(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) CAGA 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 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 Buy-down Costs, 53 FERC ¶ 61,163 (1990), order on reh'g, 54 FERC ¶ 61,095, reh'g denied, 55 FERC ¶ 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 contraeted-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-88-0008-0&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 nonreeoupable 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). 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 includes but is not limited to: Take-or-pay payments---- Payments or credits for advanced exploration or development costs or prepaid reserve payments that are subject to recoupment through credits against the purchase price or through reduced prices in later sales and which are made before production commences become part of gross proceeds as of the time of first production.
Revision of Gas Royalty Valuation Regulations and Related Topics, 53 Fed.Reg. 1230, 1275 (January 15, 1988) (promulgating 30 C.F.R. § 206.151 (1988)).
In August 1988, some lessees successfully challenged the pre-1988 rulings requiring royalties to be paid immediately on take-or-pay payments. Because the lease and the controlling statutes contemplated royalty payments on the value of the "production" of gas, the Fifth Circuit concluded that royalties were not due on take-or-pay payments at the time those payments are made. Diamond Shamrock, 853 F.2d at 1168 (emphasis added). The court reasoned that the statute contemplates royalties on gas actually produced and taken, but take-or-pay payments are "payment for the pipeline-purchaser's failure to purchase (take) gas," not payment for gas. Id. at 1167. Accordingly, "[r]oyalty payments are due only on the value of minerals actually produced, i.e., physically severed from the ground. No royalty is due on take- or-pay payments unless and until gas [that is, make-up gas] is actually produced and taken." Id. at 1168.
Rather than seeking review of the Diamond Shamrock decision or applying it only to leases within the geographic domain of the Fifth Circuit, MMS amended its gross proceeds rule to comport with the decision. It deleted the phrase "[t]ake-or-pay payments" from the definition of "gross proceeds" and determined that royalties would only accrue on take-or-pay payments when a pipeline takes make-up gas. Revision of Gross Proceeds Definition in Oil and Gas Valuation Regulations, 53 Fed.Reg. 45,082, 45,084, 45,-083 (Nov. 8, 1988). MMS also applied the rule of Diamond Shamrock in contemporaneous and subsequent administrative proceedings. See Santa Fe Energy Co., MMS-85-0046-OCS (Oct. 14, 1988), 5 Gower Fed. Serv., Royalty Valuation and Management at 4 (citing Diamond Shamrock and holding that royalties on take-or-pay payments and settlements "only become due if and when make-up gás is taken by the pipeline"); Blackwood & Nichols Co. at 2 (holding that, for a settlement agreement containing both a reeoupable and a nonrecoupable payment, only the reeoupable payment would become royalty bearing, and only "to the extent credited against future production"); Wolverine Exploration Co., MMS-88-0052-IND (May 2, 1990), 10 Gower Fed. Serv., Royalty Valuation and Management at 4 (denying royalties on a settlement payment because the payment was not "subject to recoupment through credits against the purchase price or through reduced prices in later sales").
On May 3,1993, MMS took another step in clarifying its treatment of settlement payments. In a letter from James W. Shaw, Associate Director for Royalty Management, MMS announced that "some or all of a settlement payment is or will become royalty bearing if production to which specific money is attributable occurs." Letter from James W. Shaw, Associate Director for Royalty Management, MMS, addressed to "Payor" (May 3, 1993) ("May 1993 letter"). An enclosed description of the MMS royalty policy on settlement payments is more explicit:
Consistent with [Diamond Shamrock], the [Royalty Management Program ("RMP")] interpretation and policy is that a payment or a portion of a payment is royalty bearing if the mineral to which the payment is attributable is produced and sold either to the original purchaser or a substitute purchaser, as part of the "gross proceeds" received for disposition of that production under applicable regulations.
May 1993 letter, Enclosure 1 at 1. Under this interpretation, royalties become due on settlement payments regardless of whether those payments are "reeoupable" or not — the only relevant question is whether or not the gas which was originally spoken for in the settled contracts is eventually sold to someone.
II. The Instant Dispute: Challenges by IPAA and Samedan
A. Administrative Proceedings
In 1993, the Independent Petroleum Association of America ("IPAA") filed suit in the U.S. District Court for the Northern District of West Virginia challenging the May 1993 letter and an Assistant Secretary's June 1993 order requesting information on gas contract settlements. After transfer of the case to the D.C. District Court, IPAA dismissed its challenge to the June 1993 order. Soon thereafter, DOI issued its final decision on settlement payment royalties in a case in volving gas producer Samedan Oil Corporation ("Samedan"). Samedan's ease was to become the test case for the settlement payment royalty question.
Samedan is a lessee of Indian lands under a 1979 lease which provides, in typical form, for a twenty percent royalty on the value of production which "shall not be deemed to be less than the gross proceeds accruing to the Lessee from the sale thereof." In 1981, Samedan entered into a ten-year take-or-pay gas sales agreement with Southern Natural Gas Company ("Southern"). The take-or-pay clause required Southern to pay for eighty-five percent of the eontracted-for gas in the event that it did not take the gas. A make-up clause allowed Southern to credit take-or-pay payments against "excess" or make-up gas (gas taken over and above the contract requirements) taken over the five years following the payments. By April 1985, the market price of gas had dropped to about one-fourth of the contract price, and Southern stopped taking gas from Samedan. In 1986, Southern refused to make $51,468 in take-or-pay payments billed by Samedan. On December 1, 1987, Samedan and Southern agreed to a complete buyout, terminating the 1981 contract in exchange for a "nonrecoverable and nonrefundable" $100,000 payment "in resolution and full and final settlement of any and all obligations and liabilities that Southern has or may have under the Contract." Settlement Agreement and Release at 2 (December 1, 1987). On the same day, Samedan contracted to sell the gas formerly allocated to Southern to Hadson Gas Systems ("Hadson") at the market price. Subsequently, Samedan also sold some of the gas to Transok. By 1989, Samedan had sold all the gas which would have been sold to Southern under the 1981 contract, but Southern purchased none of it.
Several years later and after an audit of Samedan's royalty obligations, MMS ordered Samedan to pay $20,000 in royalties, which represented twenty percent of the $100,000 settlement payment from Southern. MMS Service Order re Contract Settlement Between Samedan Oil Corporation and Southern Natural Gas Company Dated December 1, 1987 (December 2, 1993). MMS applied the policy outlined in its May 3, 1993 letter and concluded that $10,294 of the $100,000 payment represented compensation for already accrued take-or-pay liabilities and that the $89,706 represented a buyout payment for the remaining purchase obligations. Id Samedan made an administrative appeal, but Assistant Secretary for Indian Affairs Ada E. Deer upheld the MMS order. Samedan Oil Corp., MMS-94-0003-IND (September 16, 1994), 16 Gower Fed. Serv., Royalty Valuation and Management.
Assistant Secretary Deer first addressed the $89,706 buyout payment, considering situations where the pipeline continues to purchase gas after the settlement and situations where the gas is sold to a substitute purchaser:
The parties to a buyout arrangement . know that subsequent production will be sold at lower prices and that the lessee-producer will not obtain the same price as under the original contract. A lump-sum payment to buy out the obligation to take required volumes at higher prices therefore compensates the lessee in some degree for the reduced price the lessee will receive when the gas is produced and delivered.
The fact that a substitute purchaser, instead of the original purchaser, is involved in the buyout situation does not change the result. The result from the lessee's perspective, and the benefit to the lessee from the production, is the same regardless of the identity of the party taking delivery. If bought out volumes are produced and delivered to the substitute purchaser under a successor agreement, the amount paid by the original purchaser to be relieved of its obligation to take the gas is part of the benefit which the lessee derives from that production. The payment therefore is attributable to those volumes and becomes part of the total amount paid to the lessee for that production.
Id at 16-17. Assistant Secretary Deer found irrelevant the fact that 30 C.F.R. § 206.152(b)(1)(h) (1993), one of the regulations governing MMS' oversight of royalty payments, refers to "the total consideration actually transferred either directly or indi rectly from the buyer to the seller for the gas" (emphasis added). "[Tjhere is no reason why the term 'the buyer' in the cited regulation cannot mean both buyers under both of the sales contracts to which the gas was subject under the circumstances involved here." Samedan Oil Corp., MMS-94-0003IND at 18.
The Assistant Secretary also rejected Samedan's argument that the May 1993 letter was inconsistent with numerous prior agency decisions and positions. Id. at 18-23. She also rejected the claim that under the Administrative Procedure Act ("APA") the letter could not be validly issued without notice-and-comment rulemaking, concluding that the letter "falls well within . the exception to the APA's notice-and-comment requirements for 'interpretive rules, general statements of policy, or rules of agency organization, procedure, and practice.'" Id. at 23-24 (quoting 5 U.S.C. § 553(b)(3)(A)). She further concluded that the $10,294 payment to settle accrued take-or-pay liabilities was also subject to royalties, reasoning that such a payment makes possible future production and delivery at lower prices. "The compromise payment therefore properly is regarded as a payment in anticipation of a lower price to be received by the lessee if and to the extent that the lessee later produces the volumes to which a take-or-pay payment would have been applied." Id. at 27. Samedan also claimed that the settlement agreement was comparable to a legal judgment, which is not a payment for production, and that the imposition of royalties was inconsistent with a previous MMS decision and with prior FERC statements about the nature of take-or-pay settlement payments. The Assistant Secretary rejected these arguments as well. Id. at 30-36.
B. District Court Proceedings
Samedan sought judicial review of Assistant Secretary Deer's ruling; the District Court consolidated Samedan's challenge with IPAA's challenge to the May 1993 letter; and DOI counterclaimed to enforce its policy. The court granted summary judgment for the government on all issues in two separate opinions. Samedan Oil Corp. v. Deer, 1995 WL 431307 (D.D.C. June 14, 1995); Independent Petroleum Ass'n of America v. Babbitt, 1995 WL 431305 (D.D.C. June 14, 1995) ("IPAA").
In IPAA, the District Court considered three issues: (1) whether the May 1993 letter was a rulemaking subject to APA notice-and-comment requirements, (2) what the appropriate standard is for reviewing the Assistant Secretary's decision of September 16, 1994, and (3) whether that decision should survive the appropriate level of review. IPAA, 1995 WL 431305 at *3. The court held that the letter did not constitute a rule for APA notice-and-comment purposes. "Nothing in DOI's procedures vests authority in the Associate Director of MMS, or even the Director, to issue proclamations binding on the agency____ The court finds that the May 3 letter is not an 'agency statement,' it has no binding 'future effect,' and cannot 'prescribe law or policy.'" Id. at *4. The court also determined that even if the letter were a rule, it was exempt from notice-and-comment rulemaking because "it clearly was interpretative not substantive." Id. at *6; see also APA, 5 U.S.C. § 553(b)(A) ("[Tjhis subsection does not apply . to interpretative rules, general statements of policy, or rules of agency organization, procedure, or practice.").
The District Court next concluded that, despite the plaintiffs' protestations, it would apply to Assistant Secretary Deer's decision the deferential Chevron U.S.A, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843, 104 S.Ct. 2778, 2781-82, 81 L.Ed.2d 694 (1984), and Enron Oil and Gas Co. v. Lujan, 978 F.2d 212, 215 (5th Cir.1992), cert. denied, 510 U.S. 813, 114 S.Ct. 59, 126 L.Ed.2d 29 (1993), standards for review of an administrative agency's interpretation of its governing statute and its own rules. Id. at *8. Under Chevron, a court first asks "whether Congress has directly spoken to the precise question at issue." Chevron, 467 U.S. at 842, 104 S.Ct. at 2781. If so, the court must give effect to Congress' intent. But if the court concludes that the statute is "silent or ambiguous with respect to the specific issue," it moves to the second step of the inquiry. Id. at 843, 104 S.Ct. at 2781-82. In the second step, it defers to the agency's interpretation of the statute "if it is reasonable and consistent with the statute's purpose." Nuclear Information Resource Serv. v. NRC, 969 F.2d 1169, 1173 (D.C.Cir.1992) (internal quotation marks and citation omitted). A similar standard is applied in judicial review of an agency's interpretation of its own regulations. Such an interpretation "need only be reasonable, and not the only interpretation or the one the court would have reached if it were initially faced with the question." Enron, 978 F.2d at 215 (citation omitted). The District Court held that Deer's "construction of 'gross proceeds' is permissible, reasonable and not inconsistent with DOI regulations, nor with the governing statutes." IPAA, 1995 WL 431305 at *12. The court concluded that Deer's decision was not inconsistent with the Fifth Circuit's holding in Diamond Shamrock: "The May 3 letter covers new ground — lump-sum settlements — not touched upon by Diamond Shamrock. Only one issue was common to both situations; and treatment of that issue was totally consistent. Royalties on take-or-pay revenues are due only if make-up provisions are exercised." Id. at *10. The court also noted that, without royalties on settlement payments, "producers would have an incentive to negotiate with pipelines for large non-recoupable payments in exchange for drastically reduced future gas prices. DOI, acting on behalf of federal and Indian lessors, should not condone unjust enrichment of producers through self-serving, opportunistic settlement arrangements." Id. at *12. IPAA and Samedan appeal the District Court's decision.
In its separate Samedan opinion, the District Court considered Samedan's argument that the government's claim for royalties against Samedan is barred by the statute of limitations in 28 U.S.C. § 2415(a), which provides that all actions brought by the United States for money damages based on contract claims must be brought within six years after the claim arose or, if later, within one year of final agency action. After considering several ambiguities in the terms of the statute as applied in this case, the court concluded that (1) the Samedan lease is a contract, but (2) neither the MMS order nor the government's counterclaim "pursued money damages as that term is utilized" in the statute of limitations. Samedan, 1995 WL 431307, at *5-*6, *6. The court also noted several other reasons why the statute of limitations does not apply to the government's effort to collect the $20,000 in royalties. Id. at *6 — *11. Accordingly, it held that the government's counterclaim is not barred. Samedan appeals the District Court's decision on the statute of limitations issue.
III. Analysis of Appellants' Challenges to the May 1993 Letter and the Assistant Secretary's Decision
A. The May 1993 Letter and APA Notice-and-Comment Rulemaking
The APA defines an administrative rule as "the whole or a part of an agency statement of general or particular applicability and future effect designed to implement, interpret or prescribe law or policy." 5 U.S.C. § 551(4). The statute further requires that any such rule must be implemented through the notice-and-comment procedures of § 553, which give "interested persons an opportunity to participate in the rule making." 5 U.S.C. § 553(c). IPAA and Samedan argue that the letter constituted an agency rule subject to these requirements.
By itself, the letter did not constitute a rulemaking requiring APA notice-and-comment procedures. As the District Court found, "[njothing in DOI's procedures vests authority in the Associate Director of MMS [the letter's author], or even the Director, to issue proclamations binding on the agency. The court can not and will not invent such authority." IPAA, 1995 WL 431305 at *4. Quite simply, the May 1993 letter is not an "agency statement" with "future effect" since it did not bind the agency in any way.
Arguing that the letter constituted a rule subject to APA notice-and-comment requirements, appellants stress the test we set forth in American Mining Congress v. Mine Safety and Health Admin., 995 F.2d 1106, 1112 (D.C.Cir.1993), for distinguishing between substantive rules and interpretative rules. We held there that if a rule "effectively amends a prior legislative rule," it is a rule with "legal effect" subject to notice-and-comment requirements. Appellants contend that the letter altered DOFs past practice of excluding take-or-pay settlement payments from gross proceeds. However, even if appellants are correct in their claim that the royalty computation system in the letter departed substantially from a prior legislative rule, the letter would not itself constitute a "rule" subject to notice-and-comment requirements. Id. The letter is not an agency rule at all, legislative or interpretative, because it does not purport to, nor is it capable of, binding the agency. However, appellants' arguments about DOFs past practice with regard to take-or-pay settlements are relevant to our evaluation of the Assistant Secretary's decision in the Samedan case, and we will consider them as we now turn to appellants' challenges to that decision.
B. The Assistant Secretary's Decision 1. Standard of Review
We review actions of administrative agencies under the arbitrary and capricious standard of the APA, 5 U.S.C. § 706(2)(A). As we noted earlier, in our review we defer to an agency's reasonable interpretation of a statute it is entrusted to administer so long as it is not inconsistent with the unambiguously expressed congressional intent. Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43, 104 S.Ct. 2778, 2781-82, 81 L.Ed.2d 694 (1984). As the District Court noted, "[djeference is even more clearly in order when an agency interprets its own administrative regulations." IPAA, 1995 WL 431305 at *6 (citing Udall v. Tollman, 380 U.S. 1, 16, 85 S.Ct. 792, 801, 13 L.Ed.2d 616 (1965)). The relevant statutes in this ease provide that royalties shall be based on the "amount or value of the production" saved, removed, or sold by the lessee. See OCSLA, 43 U.S.C. § 1337(a)(1); MLA, 30 U.S.C. § 226; 25 C.F.R. § 211.13 (tribal leases); 25 C.F.R. § 212.16 (Indian allotted land leases). The relevant regulation is the gross proceeds rule.
Appellants argue that normal administrative law standards do not apply in this case. They claim, as they did in the District Court, that Assistant Secretary Deer's decision does not actually interpret statutes and agency rules, but instead interprets the Fifth Circuit's decision in Diamond Shamrock, which, they contend, has already addressed the controversy at issue in this case. They argue that DOFs "reinterpretation" of Diamond Shamrock is problematic because DOI has already amended its regulations to comply with Diamond Shamrock. See supra at 112 (citing Revision of Gross Proceeds Definition in Oil and Gas Valuation Regulations, 53 Fed.Reg. 45,082, 45,084, 45,083 (Nov. 8, 1988)). Thus, they claim, the agency is bound by its own hand — it is its own acquiescence in Diamond Shamrock that bars it from "reinterpreting" that decision. Because the court, and not an administrative agency, is the proper place for construing past judicial decisions, appellants contend that we should not defer to DOFs interpretations. By implication, we would also not afford the Assistant Secretary's decision the benefit of the APA's arbitrary and capricious standard, as Diamond Shamrock has already determined the outcome of the APA analysis.
Appellants cite in support of their claim that we should not defer to DOI's interpretation of Diamond Shamrock the United States Supreme Court's statement that "[o]nce we have determined a statute's clear meaning, we adhere to that determination under the doctrine of stare decisis, and we judge an agency's later interpretation of the statute against our prior determination of the statute's meaning." Maislin Industries, U.S., Inc. v. Primary Steel, Inc., 497 U.S. 116, 131, 110 S.Ct. 2759, 2768, 111 L.Ed.2d 94 (1990). But Diamond Shamrock is not stare decisis in this case. Diamond Shamrock is deserving of respect as a decision of a sister circuit, but it is not binding authority on us. The cited language from Mcdslin is therefore not on point.
This is not to say that the agency's acquiescence in the Fifth Circuit's decision is irrelevant or unimportant. Under Chevron, DOFs interpretation of the gross proceeds rule is held only to a standard of reasonableness, but the interpretation must be reasonable in light of DOI's adoption of Diamond Shamrock Under APA § 706(2)(A) review, the Assistant Secretary's decision must satisfy the arbitrary and capricious standard insofar as it treats contract settlement payments differently from the way it treats take-or-pay payments under Diamond Shamrock An agency must treat similar cases in a similar manner unless it can provide a legitimate reason for failing to do so. See National Association of Broadcasters v. FCC, 740 F.2d 1190, 1201 (D.C.Cir.1984) (stating that the agency could not depart from its conclusion in a prior decision without reasoned explanation).
As we have noted in the past, "Chevron review and arbitrary and capricious review overlap at the margins." Arent v. Shalala, 70 F.3d 610, 615 (D.C.Cir.1995); National Ass'n of Regulatory Util. Comm'rs v. ICC, 41 F.3d 721, 728 (D.C.Cir.1994). The instant case falls within that overlap. A determination that DOI has acted inconsistently with its adoption of Diamond Shamrock could be phrased as a conclusion that the agency's interpretation is unreasonable in light of its adoption of the Fifth Circuit's decision or that the agency had acted arbitrarily in treating take-or-pay settlement payments differently from take-or-pay payments, which are governed by the agency's adoption of Diamond Shamrock. The two analytic frameworks in this case produce the same result. Because the question at the root of the analysis is whether DOI has treated the two types of payments differently, the arbitrary and capricious analytic framework is the most apt. However, we stress that, within the boundaries of this case, a determination that the Assistant Secretary's decision is arbitrary and capricious in light of DOFs adoption of Diamond Shamrock is functionally equivalent to a determination that DOFs interpretation of the gross proceeds rule is unreasonable under Chevron. That is, in this case, if DOFs interpretation of the gross proceeds rule is unreasonable, it is unreasonable because the application of that interpretation in the case of take-or-pay settlement payments constitutes an unexplained departure from the agency's adoption of Diamond Shamrock. See National Association of Broadcasters, 740 F.2d at 1201.
Amicus the Jicarilla Apache Tribe also argues for a standard of review different from the administrative law standards we normally apply. According to the Tribe, we are to review the Assistant Secretary's decision not under the arbitrary and capricious standard, but under the rigorous standard of a fiduciary duty owed by DOI to Indian tribes who are leasing Indian lands. Among other things, the Tribe relies on a Tenth Circuit opinion which states that this fiduciary duty to Indian oil and gas lessors requires that DOFs "actions must not merely meet the minimal requirements of administrative law, but must also pass scrutiny under the more stringent standards demanded of a fiduciary." Jicarilla Apache Tribe v. Supron Energy Corp., 728 F.2d 1555, 1563 (10th Cir.1984) (Seymour, J., concurring in part and dissenting in part), adopted as majority en banc opinion, 782 F.2d 855, 857 (10th Cir.), cert. denied, 479 U.S. 970, 107 S.Ct. 471, 93 L.Ed.2d 416 (1986). We find it unnecessary to consider the Tribe's fiduciary duty argument. Even if the Assistant Secretary's decision should be subject to this standard, it must also pass the APA's arbitrary and capricious test. Because we conclude below that the decision fails to meet the arbitrary and. capricious test, we need not reach the fiduciary duty issue.
We now proceed to examine the Assistant Secretary's decision under the APA's arbitrary and capricious standard of review.
2. Analysis
We must decide whether it was arbitrary and capricious for DOI to conclude that take-or-pay.settlement payments are royalty bearing in light of its determination (following Diamond Shamrock) that take-or-pay payments themselves are not royalty bearing until those payments are specifically allocated to gas that is physically severed from the ground. We conclude that DOI has failed to give a sufficient nonarbitrary reason for treating the two types of payments differently-
We begin our analysis with an examination of the basis for the holding in Diamond Shamrock. The Fifth Circuit placed heavy emphasis on the necessary link between royalties and actual production of gas, finding it "obvious" from the relevant statutes, regulations and lease provisions that royalties "are not due on 'value' or even 'market value' in the abstract, but only on the value of production saved, removed or sold from the leased property." Diamond Shamrock, 853 F.2d at 1165. Similarly, the court determined that the gross proceeds rule applies "only to gross proceeds that accrue to the lessee from the disposition or sale of produced substances, that is, gas actually removed and delivered to the pipeline." Id.
DOI argues that the required connection between royalties and physical severance must be temporal only; that is, royalties on payments accrue when gas is produced, regardless of whether those payments came from the purchaser of the gas. But this reading does not account for Diamond Shamrock's emphasis on the link between royalties and physical severance. Under Diamond Shamrock, at the time of a settlement payment or a take-or-pay payment, no production has occurred; therefore no royalties accrue. But when make-up gas is taken, a portion of the take-or-pay payment is credited as payment for the make-up gas. It is therefore reasonable to collect royalties on these funds, which have just been transformed into payments for gas produced.
That is what the Fifth Circuit relied upon in its Diamond Shamrock decision — the existence of a direct link between the funds upon which royalties are imposed and the physical severance of gas. This is how DOI read Diamond Shamrock when it revised its royalty regulations in 1988. In describing the Diamond Shamrock holding, DOI quoted from the court's introduction to the case, inserting the bracketed material: "the court ruled that '... royalty payments are not due on take-or-pay payments and are only due on gas actually produced and taken \i.e., so-called "make-up" gas].'" Revision of Gross Proceeds Definition in Oil and Gas Valuation Regulations, 53 Fed.Reg. 45,082, 45,082 (November 8, 1988). DOI thus demonstrated that it understood Diamond Shamrock to be saying that royalties would only be due on take-or-pay type payments when those payments were recouped. Two sentences later in its revision order, DOI quoted from the court's conclusion with the bracketed insertion: "No royalty is due on take-or-pay payments unless and until gas [namely, make-up gas] is actually produced and taken." Id. at 45,083. This insertion emphasizes that DOI read Diamond Shamrock in 1988 as we read it today. This fact is important because, as we noted in the previous subsection, it is the agency's adoption and application of Diamond Shamrock that is the relevant consideration. DOI cites another Fifth Circuit case, Frey v. Amoco Production Co., 943 F.2d 578 (5th Cir.1991), vacated for review by Louisiana Supreme Court, 951 F.2d 67, Part IIA reinstated, 976 F.2d 242 (5th Cir.1992), in an attempt to demonstrate that even the Fifth Circuit reads Diamond Shamrock more narrowly than appellants. In Frey, the Fifth Circuit held that royalties are owed on contract settlement payments. However, Frey is inapposite. In that decision, the Fifth Circuit distinguished Diamond Shamrock not on the basis of any functional difference between take-or-pay payments and settlement payments, but on the grounds that Frey involved different lease language to be construed not under federal law but under Louisiana law. Frey, 943 F.2d at 581.
Under Diamond Shamrock's construction of the royalties statute as requiring a link between payments subject to royalty and the physical severance of gas, there is no meaningful distinction between a settlement payment and a recoupable take-or-pay payment in that no gas is actually produced in either case. But unlike the recoupable take-or-pay payment, a nonrecoupable settlement payment is never credited as payment for any gas actually severed from the ground. When gas is actually severed and sold to a substitute purchaser, the settlement payment does not serve as payment for the gas. The link between the funds on which royalties are claimed and the actual production of gas is missing.
It is possible to argue, of course, that DOI merely adopted the holding in Diamond Shamrock but not the reasoning of the opinion. Under this scenario, DOI could collect royalties on settlement payments because Diamond Shamrock did not address settlement payments. The problem with this line of reasoning is that, as we have already explained, DOI has read Diamond Shamrock as requiring a link between royalty-bearing payments and severed gas and has regulated accordingly. An agency cannot meet the arbitrary and capricious test by treating type A cases differently from similarly situated type B eases because a court once decided a type A case against the agency where the rationale of the court decision applies to both. The treatment of cases A and B, where the two cases are functionally indistinguishable, must be consistent. That is the very meaning of the arbitrary and capricious standard.
Take-or-pay payments and contract settlement payments are functionally indistinguishable with respect to the calculation of royalties. Both types of payments satisfy outstanding take-or-pay obligations, and both types can be recoupable or nonrecoupable. The only difference is whether the payments follow negotiations between the parties over the cancellation of contractual obligations. We see no way in which the occurrence of these negotiations changes the functional nature of the payments for royalty purposes. The relevant question in both cases, under Diamond Shamrock, is whether or not the funds making up the payment actually pay for any gas severed from the ground. When take-or-pay payments (or settlement payments) are recouped, those funds do pay for severed gas. But when the payments (of either variety) are nonrecoupable, the funds are never linked to any severed gas. Therefore, no royalties accrue on those payments.
Under the preceding analysis, we find Assistant Secretary Deer's decision in Samedan Oil Corp.' arbitrary and capricious in light of DOI's adoption of the Diamond Shamrock holding. Neither take-or-pay payments nor take-or-pay settlement payments are royalty bearing unless and until they are credited toward the purchase of make-up gas.
IV. Conclusion
Having reviewed Assistant Secretary Deer's decision in Samedan Oil Corp. and found it to be arbitrary and capricious in light of DOI's acquiescence in the Fifth Circuit's decision in Diamond Shamrock, we reverse the District Court's granting of summary judgment against appellants and hold that DOI is precluded from collecting royalties on the $100,000 settlement payment made by Southern to Samedan. Because we conclude that DOI cannot collect any royalties on the settlement payment, it is unnecessary for us to consider appellant Samedan's statute of limitations claim.
. The version of the gross proceeds rule in effect on December 1, 1987, the date of the making of the take-or-pay settlement at the source of this litigation, did not differ in any substantive manner. That version provided that "[u]nder no circumstances shall the value of production of any of said substances for the purposes of computing royalty be deemed to be less than the gross- proceeds accruing to the lessee from the sale thereof." 30 C.F.R. § 206.103 (1987). The current wording of the gross proceeds rule was adopted in 1988. See Revision of Gas Royalty Valuation Regulations and Related Topics, 53 Fed.Reg. 1230, 1275 (January 15, 1988) (promulgating 30 C.F.R. § 206.151 (1988)).
. The District Court held that, even if the letter constituted an APA rule, notice-and-comment rulemaking was not required because the letter would qualify as an interpretative rule. IPAA, 1995 WL 431305 at *4-*6. Interpretative rules and general statements of agency policy are exempt from notice-and-comment requirements. 5 U.S.C. § 553(b)(A). Because of our holding that the letter does not constitute a rule at all, we find it unnecessary to consider whether it would qual ify for the interpretative rule exception if it were a rale.
. We do not by this reasoning dispute the dissent's proposition that agencies have the power of nonacquiescence in decisions of a single circuit. Dissent at p. 120 & n. 3 & n. 4. That proposition is simply inapplicable here. The Secretary did not refuse to acquiesce in Diamond Shamrock, but instead amended the applicable regulations with accompanying explanations adopting and interpreting Diamond Shamrock. While free to refuse acquiescence, the Secretary is not free, for the reasons set forth in the text, to adopt the Diamond Shamrock rule for some purposes but arbitrarily and capriciously reject it for others.
. We do not understand our colleague's rejection of the proposition that Diamond Shamrock depends on recoupability. The, portion of the Diamond Shamrock opinion quoted by our colleague on p. 8 expressly reflects that "no royalty is due on take-or-pay payments unless and until gas [namely, make-up gas] is actually produced and taken." Dissent at p. 123. It is not clear to us how the production and taking of make-up gas could ever occur absent recoupability.