Opinion ID: 2629624
Heading Depth: 1
Heading Rank: 8

Heading: Issue II. Proportionate Profits Method

Text: [¶ 53] As discussed above, severance taxes are levied on the value of the natural gas at the point where the production process is completed. Wyo. Stat. Ann. § 39-142-03(b)(ii). The gas from the LaBarge Project is not sold at that point. Instead, ExxonMobil sells it after the gas has been processed and separated into products including methane, carbon dioxide, and sulfur. The amount ExxonMobil actually receives when it sells those products represents their higher value after processing and separation. An accounting method must be used to reduce the amount ExxonMobil actually receives for the products to reflect the lower value at the point where the production process is completed. [¶ 54] The method chosen by the Department for calculating the value of ExxonMobil's 2005 production is the proportionate profits method set forth in Wyo. Stat. Ann. § 39-142-03(b)(vi)(D): Proportionate profits  The fair market value is: (I) The total amount received from the sale of the minerals minus exempt royalties, nonexempt royalties and production taxes times the quotient of the direct cost of producing the minerals divided by the direct cost of producing, processing and transporting the minerals; plus (II) Nonexempt royalties and production taxes. A much-simplified example can illustrate how the proportionate profits method works. A company sells its natural gas for $100, which is, in the words of the statute, the total amount received from the sale of the minerals. The direct cost of producing the minerals is $30. The direct cost of producing, processing and transporting the minerals is $50. Applying the statutory formula, the fair market value is calculated as follows: $100 x ($30 ÷ $50) = $60. This establishes the value of the natural gas at the time production was completed as $60, and the severance tax would be levied on this amount. [¶ 55] In its order, the Board provided this broad explanation of how the proportionate profits method applies to ExxonMobil: Under Wyoming law, the fair market value of natural gas production is determined at the point when the production process has been completed. Wyo. Stat. [Ann. §] 39-2-208(a). The LaBarge raw gas stream, however, must undergo extensive processing in order to have marketable products. For this reason the amount received from the sale of the products from the raw gas stream reflects the value of those products after both production and processing. In order to determine the value of the products after production only, it is necessary to deduct from the total amount received from the sale an amount reflecting the value added to the products by processing. The purpose of the direct cost ratio in the proportionate profits methodology is to allocate a portion of a taxpayer's revenue to non-taxable functions, i.e. processing and transporting. RME Petroleum Company v. Wyoming Department of Revenue, 2007 WY 16, ¶ 51, 150 P.3d 673, 691 (Wyo. 2007). [¶ 56] The dispute between the Department and ExxonMobil concerns the costs ExxonMobil incurs in transporting methane, carbon dioxide, and sulfur products to their respective points of sale after they have been processed and separated from the natural gas stream. The parties agree that post-processing transportation costs must be factored into the calculation, but disagree about how that should be done. The Department subtracted the post-processing transportation costs from the total amount received from the sale of the minerals. ExxonMobil contends that this is contrary to the statutory formula, and that post-processing transportation costs must instead be included in the denominator of the direct cost ratio. [¶ 57] The Department maintains that the result of including the post-processing transportation costs in the direct cost ratio is a compelling reason to reject ExxonMobil's position. The post-processing transportation costs are particularly high for carbon dioxide, because it must be compressed and sent long distances through pipelines to the eventual points of sale. The Department points out that including the post-processing transportation costs for carbon dioxide reduced taxable value for the gas stream to such an extent that not taxing [carbon dioxide] at all generated a higher taxable value in the remaining minerals taxed.  (Emphasis supplied by the Department.) The Department claims that this is an absurd result that should be avoided when interpreting the statute. See Chevron U.S.A., Inc. v. Department of Revenue, 2007 WY 43, ¶ 18, 154 P.3d 331, 337 (Wyo. 2007). [¶ 58] We disagree that this result is absurd. Severance taxes are levied on the fair market value of the mineral after the production process is completed. Wyo. Stat. Ann. § 39-14-203(b)(ii). If it is unusually expensive to transport a mineral from the point of production to the point of sale, then that mineral has a lower fair market value at the point of production. More specifically, if the carbon dioxide component of the LaBarge raw gas stream is extremely expensive to transport, then the value of the carbon dioxide at the point of production is correspondingly low. If the value of the carbon dioxide is low, that reduces the value of the entire gas stream at the point of production. In fact, as we have previously observed, when natural gas prices are particularly low, the LaBarge gas stream may have zero taxable value under some accounting methods. See Wyoming Dep't of Revenue v. Exxon Mobil Corp., 2007 WY 21, ¶ 3, 150 P.3d 1216, 1218 (Wyo. 2007). [¶ 59] The statutory formula for the proportionate profits method explicitly includes the direct cost of producing, processing and transporting the minerals in the denominator of the direct cost ratio. Wyo. Stat. Ann. § 39-14-203(b)(vi)(D). The use of the plural, minerals, indicates that the transportation costs for all components of the raw gas stream must be included in the formula. The statute does not allow the Department to include the direct costs of some minerals and exclude the direct costs of others. While the Department may be correct that including the high costs of post-processing transportation for carbon dioxide results in a lower taxable value for the entire gas stream, that result is not absurd but rather a reflection of the true market value of the LaBarge gas stream at the point of production. The result is entirely consistent with the mandate of the Wyoming Constitution that the product of all mines shall be taxed in proportion to the value thereof. Wyo. Const. art. 15, § 3. [¶ 60] The Department asserts that post-processing transportation costs are not included in the direct cost ratio because they are incurred to transport the separate products of the gas stream rather than the collective gas stream. The Board agreed with this contention: When individual mineral products are separated through processing as defined by statute, the producer may incur post-plant costs for transporting that particular mineral product to the point of sale. Those costs do not proportionately enhance the value of the other mineral products. Post-plant transportation costs thus bear no relevance to the value added by processing, and, therefore, do not belong in the direct cost ratio. [¶ 61] However, Wyo. Stat. Ann. § 39-14-201(a)(xv) explicitly provides that, For the purposes of taxation, the term natural gas includes products separated for sale or distribution during processing of the natural gas stream including, but not limited to plant condensate, natural gas liquids and sulfur. Methane, carbon dioxide, and sulfur are all products separated from the LaBarge Project natural gas stream, and all are included within the definition of natural gas for purposes of taxation. Because the Department levies taxes on the value of each individual product, it must also consider the costs of transporting each individual product. [¶ 62] The key to resolving this dispute, we believe, is to determine whether post-processing transportation costs are part of the direct cost of producing, processing and transporting the minerals. If so, then Wyo. Stat. Ann. § 39-14-203(b)(vi)(D) directs that they be included in the denominator of the direct cost ratio. This is the position taken by ExxonMobil. The position taken by the Department, though never expressly stated this way, is that post-processing transportation costs are indirect costs. The Department's regulations provide this definition of direct costs: Direct costs of producing, processing and transporting includes the direct cost of producing . . . plus transportation and processing plant or facility labor whose primary purpose is transporting or processing crude oil, plant condensate, natural gas and other mineral products removed from the production stream; materials and supplies used for transporting and processing; depreciation expense for equipment used for transportation and processing; fuel, power and other utilities used for transportation and processing and maintenance of the transporting and processing plant or facilities; transportation from the point of valuation to the processing plant or facility to the extent included in the price and provided by the producer; ad valorem taxes on the transporting equipment and processing plant or facility; and any other direct costs incurred that are specifically attributable to the transporting or processing of mineral products contained in the production stream. Department of Revenue Rules, ch. 6, § 4b(x). The Department contends that because the definition of direct costs expressly includes the costs of transportation from the point of valuation to the processing plant or facility, it impliedly excludes costs incurred after the processing plant or facility. [¶ 63] The Department has overlooked another phrase in this regulation, which states that direct costs include any other direct costs incurred that are specifically attributable to the transporting or processing of mineral products contained in the production stream. Post-processing transportation costs are specifically attributable to transporting the methane, carbon dioxide, and sulfur products contained in the gas stream. This provision of the regulation substantially undermines the Department's position that post-processing transportation costs are not direct costs. [¶ 64] The statutes and regulations provide no definition of the term indirect costs as applied to natural gas. As applied to coal, however, indirect costs are defined to include allocations of corporate overhead, data processing costs, accounting, legal and clerical costs, and other general and administrative costs which cannot be specifically attributed to an operational function without allocation. Wyo. Stat. Ann. § 39-14-103(b)(vii)(D). Applying this statutory definition, we have observed that, for example, the costs of mining permits and environmental impact statements are indirect costs because they benefit the entire operation and cannot be specifically attributed to any coal mining or processing function. Powder River Coal Co. v. Wyoming State Bd. of Equalization, 2002 WY 5, ¶ 22, 38 P.3d 423, 430 (Wyo. 2002). Although this statutory definition applies directly to coal, we also find it helpful in defining indirect costs of producing natural gas. [¶ 65] The post-processing transportation costs for methane, carbon dioxide, and sulfur are not general administrative costs that benefit the entire project. They are directly attributable to the function of transporting those mineral products. Reading this statutory definition of indirect costs together with the regulatory definition of direct costs, we must conclude that post-processing transportation costs are not indirect costs, but direct costs. Accordingly, post-processing transportation costs must be included in the denominator of the statutory formula for calculating the fair market value of the minerals using the proportionate profits method. [¶ 66] Even if these post-processing transportation costs were indirect costs, however, the Department has provided no case law support for the approach of subtracting them from total sales. In Powder River, ¶ 18, 38 P.3d at 429, we explained that The proportionate profits method adopted by the legislature recognizes that indirect costs occur proportionately over all functions, production, processing, and transportation, in the same ratio as direct costs. Accordingly, Wyo. Stat. Ann. § 39-14-203(b)(vi)(D) requires a calculation of the ratio of direct costs of production to the direct costs of production, processing, and transportation. It does not require a calculation of indirect costs in this formula, but instead presumes that indirect costs occur in the same ratio as direct costs. The statutory formula, as interpreted in Powder River, does not mention indirect costs, and therefore cannot be interpreted to authorize the Department's approach of subtracting indirect costs from total sales. [¶ 67] The Department has cited no statutory or regulatory authority for its approach of subtracting post-processing transportation costs directly from the amount received in sales. The applicable statute, Wyo. Stat. Ann. § 39-14-203(b)(vi)(D), is explicit about what is included in this step of the formula: The total amount received from the sale of the minerals minus exempt royalties, nonexempt royalties and production taxes. It does not indicate, in any way, that post-processing transportation costs are also subtracted from the sales amount. [¶ 68] For all of these reasons, we conclude that Wyo. Stat. Ann. § 39-14-203(b)(vi)(D) is unambiguous on the correct way to account for post-processing transportation costs. Post-processing transportation costs are direct cost[s] of producing, processing and transporting the minerals. They must therefore be included in the denominator of the direct cost ratio under the proportionate profits method.