Opinion ID: 510046
Heading Depth: 2
Heading Rank: 2

Heading: What is the Value of Production?

Text: 27 The royalty provision in the instant lease provides that royalty will be paid on the amount or value of the production. 26 In regulations, the Department of the Interior has further defined value of production as fair market value. 27 At a minimum, fair market value is at least the gross proceeds accruing to the lessee from the disposition of the produced substances. 28 Fair market value is to be determined by considering several factors, which include posted prices, prices paid under comparable contracts, as well as prices paid for nonjurisdictional sales, the price actually received by the lessee, and other relevant matters. 29 28 To accept the DOI's interpretation would lead to absurd results. For example, if royalty is payable currently when the take-or-pay payment is made, what happens when the pipeline later takes make-up gas? If the fair market value of gas rises, the pipeline is usually responsible for paying for the make-up gas at the increased market value. The government of course gets its proportionate share of the increased market value as royalty for the make-up gas now taken. The lessee-producer then has to pay the additional royalty due on the increased fair market value, necessitating two royalty payments on one purchase of gas. 29 If the price of gas drops, depending on the contract, the pipeline-purchaser could be due a refund. 30 If the pipeline gets a refund, then certainly it would be equitable for the lessee-producer to get a refund on overpaid royalties. A problem arises here with the length of the make-up period, usually 7 years, being longer than the statute of limitations against the government. 31 In this situation, it is quite possible that producers would never be able to recover overpaid royalties on take-or-pay payments. 30 If, as the DOI suggests, the fair market value of gas includes the amount of take-or-pay payments, then what result if no gas is taken? If no gas is taken under an exclusive sales contract, there is no market for that gas, therefore no market value of that gas. But there is a take-or-pay payment. Is that the fair market value of non-sold gas? With no production there is nothing to value either by market or otherwise. 31