Opinion ID: 6336934
Heading Depth: 2
Heading Rank: 1

Heading: ONRR’s Valuation

Text: We first will consider whether the Director erred in determining that ONRR reasonably established a minimum value for Hess to use to calculate the value of its federal CO2 production. ONRR’s valuation used (1) the “weighted average” from January 2002 to September 2003 and April 2008 to November 2010, and (2) the Smithson formula from October 2003 to March 2008. ROA, at 273–74. At the outset of the Director’s decision, the Director noted that the approved Unit Agreement, along with the underlying Leases, required the federal lessees to pay royalties on the higher of either (1) the net proceeds derived from the sale of CO2 gas at the well, or (2) a minimum value established by the United States. Id. at 429 [§ 6.3], 465. Recall that if the applicable 1988 regulation is inconsistent with a lease, then the lease governs to the extent of that inconsistency. 30 C.F.R. § 206.150(b). The 1988 regulations authorize a lessee to first compute the minimum royalty value through the benchmark system, and ONRR is then empowered to determine whether the lessee’s valuation is inconsistent with the applicable regulations. §§ 206.152(c)(1)–(3), 206.152(e)(1). In contrast, under the Unit Agreement and underlying Leases, the Secretary retains the right to establish the royalty value on CO2 production based on the Lease valuation factors following notice and an opportunity to be heard when appropriate. After comparing the regulations and the 24 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 25 Unit Agreement, the Director determined that “[t]he Leases and Unit Agreement govern the value of Hess’s CO2 for federal royalty purposes” because “the Secretary retained the right to establish a minimum value for federal CO2 production in the Unit in its approval of the Unit Agreement.” ROA, at 227–28, 239. Because Hess did not sell the CO2 production at issue, the Director evaluated ONRR’s valuation under the Lease valuation factors to see if ONRR had properly established a reasonable minimum value, after giving Hess notice and an opportunity to be heard: (1) The Highest Price Paid for a Part or for a Majority of Production of Like Quality in the Same Field: The Director explained that federal lessees in the Unit (holding less than ten percent of an interest in the Unit) sell less than one percent of the CO2 produced from the federal lands. Federal lessees use the remainder in their EOR operations. ONRR only had data for the federal CO2 production and considered that data set, but the agency reasonably concluded that the data set was too small to accurately establish a minimum value. ONRR also could not consider the Hess Purchase Contracts under the first factor because the agency could not determine whether such contracts represented the “highest price paid” for a part or majority of production from the Unit. The Director concluded that ONRR had properly considered this factor. (2) The Price Hess Received for the CO2: ONRR considered the Fasken Contract in the context of the “weighted average” calculation, but because this represented a very small fraction of Hess’s federal CO2 disposition, ONRR determined that it could not solely rely on these prices alone. The Director concluded that ONRR had properly considered this factor. (3) Posted Prices: ONRR could not consider posted prices for CO2 production because no posted prices for CO2 in the Unit existed during the audit period. The Director concluded that ONRR had properly considered this factor. (4) Other Relevant Matters: ONRR considered the Unit Average, the prices at which Hess purchased CO2 under the Hess Purchase Contracts, 25 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 26 and pricing mechanisms used in Hess’s settlements and arbitrations, including the Smithson formula. The Director found that these considerations were reasonable, as they helped ONRR identify reliable indicators of value. The Director concluded that ONRR had properly considered this factor. Id. at 227–39; see also id. at 442b, 446b, 450b, 454b [Sec. 2(d)(2)]. The Director concluded overall that there was insufficient information as to the first and third factors, so ONRR’s reliance on the second and fourth factors to establish its valuation was reasonable. In determining that ONRR’s valuation was reasonable, the Director explained why ONRR’s consideration of the Smithson arbitration was proper: (1) the arbitration panel found that Hess had negotiated lower fixed prices for its CO2 purchases and then had used those lower prices to value the CO2 for royalty purposes; (2) Hess “had the full opportunity to challenge and offer alternatives to the method the arbitration panel used to calculate value and damages”; and (3) the arbitration panel “used a formula price that took into account Hess’s argument for a flat price,” as well as the suggestions of Hess’s valuation specialist. Id. at 236–37. The Director also explained why Hess’s Unit Average could not be used to determine the value of Hess’s CO2 production: (1) it was “extremely difficult to verify the prices under the Unit Average are consistent with federal valuation requirements”; (2) the Unit Average “results in a value that is less than the price Hess is willing to pay for CO2”; and (3) the Unit Average likely included prices from non-arm’s-length CO2 sales. Id. at 234–36, 253. The Director observed that ONRR and New Mexico had provided Hess ample notice through correspondence that the 26 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 27 agency was considering a different valuation method than the Unit Average. New Mexico sent Hess two audit letters indicating that the Unit Average was not an appropriate basis for Hess to use to value its federal CO2 production, to which Hess responded. Id. at 238. The Director further concluded that ONRR never had demanded that Hess use the Unit Average valuation in perpetuity, as Hess seemed to claim. Id. at 248–53. Hess argued that ONRR consistently had required Hess to use the Unit Average to value its CO2 and that the Unit Average originated from an Amoco proposal to ONRR on how Amoco should value its federal CO2 production from the Unit. Id. at 248. The Director examined the sources on which Hess relied and explained in detail that they did not amount to the agency’s endorsement of the Unit Average, but to the extent they did, any such guidance was based on the facts presented at the time and did not bind the agency to the Unit Average methodology decades later. Id. at 248–53. After analyzing the reasonableness of ONRR’s valuation under the Lease valuation factors and rejecting the Unit Average, the Director determined that “the result would be the same even if the federal gas royalty valuation regulations controlled the outcome of this case.” Id. at 239 (citing 30 C.F.R. § 206.152(c)(2)). The Director considered ONRR’s valuation under each of the second benchmark regulatory factors: (1) The Gross Proceeds Under Arm’s-Length Contracts for Like-Quality Gas in the Same Field or Nearby Fields or Areas: ONRR considered the gross proceeds under arm’s-length contracts for like quality gas, 27 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 28 including the arm’s-length Fasken Contract. The Fasken Contract was the only contract in the record that ONRR could verify as an arm’s-length contract. The Director concluded that ONRR had properly considered this factor. (2) Posted Prices: ONRR observed that the record did not include any evidence of posted prices, so the agency could not evaluate this factor. The Director concluded that ONRR had properly considered this factor. (3) Prices Received in Arm’s-Length Spot Sales: ONRR observed that the record did not include any evidence of prices received in arm’s-length spot sales, so the agency could not evaluate this factor. The Director concluded that ONRR had properly considered this factor. (4) Other Reliable Public Sources of Price or Market Information: ONRR considered the Smithson formula and Hess’s other settlements as a means to determine value, but as discussed, it determined that the Smithson formula was a more appropriate and reliable indicator of value for the period of October 2003 through December 2008. The Director concluded that ONRR had properly considered this factor. (5) Other Information Particular to a Lease Operation or Saleability of the Gas: Here ONRR considered the Hess Purchase Contracts and the Unit Average that Hess had used as the basis for its royalty payments. ONRR ultimately concluded that the Hess Purchase Contracts were a more appropriate indicator of value than the Unit Average and used the Hess Purchase Contracts as part of its final “weighted average” valuation. The Director concluded that ONRR had properly considered this factor. Id. at 242–43. The Director concluded overall that ONRR had considered every potential indicator of value in the record under the second regulatory benchmark. On appeal, OXY raises three issues regarding ONRR’s valuation: (1) the Director incorrectly concluded that ONRR’s valuation was reasonable under the Lease valuation factors; (2) the Director improperly rejected Hess’s Unit Average as the valuation method; and (3) the Director misapplied the 1988 regulatory factors to alternatively affirm the agency’s valuation under the second regulatory benchmark. 28 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 29
OXY first argues that ONRR’s valuation is unreasonable and arbitrary. While OXY does not provide any meaningful challenge to ONRR’s consideration of the Fasken Contract or the Hess Purchase Contracts, OXY repeatedly asserts that ONRR’s consideration of the Smithson formula was inappropriate because the arbitration decision did not involve federal leases and only resolved a royalty dispute between Hess and private lease owners. Aplt. Br. at 11–12, 45–47. In making this argument, OXY contends that the Smithson formula never had been used to buy or sell any CO2; the Smithson formula was not legally binding because the parties settled after arbitration and the Smithson formula was not agreed to in the settlement; arbitration awards and decisions have no precedential effect in other cases; and the Smithson formula does not qualify as relevant evidence under the Lease valuation factors or the 1988 regulatory factors. Id. at 46–49. Relatedly, OXY argues that if the agency rejected the Unit Average due to the inclusion of non-arm’s-length transactions, then it should not have considered the Smithson formula because it included non-arm’s-length transactions. 12 Id. at 43, 49. 12 OXY also argues that ONRR’s valuation is arbitrary and inconsistent because “[t]he history of this matter involves no less than four administrative decisions differently valuing [Hess’s] Audit Period CO2 production.” Aplt. Br. at 19 (emphasis in original). OXY characterizes this history as “a vacillating scattershot of substitute methodologies to re-value [Hess’s CO2 production].” Id. In actuality, OXY is referencing the aforementioned correspondence that occurred among New Mexico, ONRR, and Hess during the audit process, and as discussed, the record shows that ONRR only issued one Order to Report and Pay Additional Royalties on 29 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 30 We conclude that the Director considered all relevant evidence and provided sufficient reasoning for each of ONRR’s determinations regarding the valuation. Under the deferential APA standard, we ask whether the agency’s decision was based on an examination of the relevant evidence and if the agency “articulated a rational connection between the facts found and the decision made.” Payton, 337 F.3d at 1168. The Director’s methodology and detailed explanations certainly pass muster under the APA’s deferential framework. The agency considered all relevant information that was reasonably available, including the single arm’s-length Fasken Contract, the Hess Purchase Contracts, and the Smithson formula for production occurring between October 2003 and March 2008. ROA, at 233–37. The Director then articulated a rational connection between the relevant information and ONRR’s valuation under the Lease valuation factors and weighed the factors accordingly. Id. The Director then analyzed the second regulatory benchmark factors at length and explained why the result would be the same if the regulatory valuation factors applied. Echoing the district court, we cannot reweigh the evidence, which seems to be what OXY is requesting. As to the Smithson formula, the agency was clear that consideration of this formula was appropriate because the question under both Hess’s Leases and the 1988 regulations—the reasonable value of Hess’s CO2 based on all relevant and reliable December 19, 2011, which ONRR’s Director then reduced in OXY’s favor on review. See ROA, at 217–54, 270–82. 30 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 31 information—was fundamentally the same inquiry that the Smithson arbitration panel conducted. During the audit, the agency discovered that Hess did not have other reliable public sources of price or market information for the audit period, except for the negligible Fasken Contract. The agency realized that the Smithson formula provided an appropriate and reliable indicator of value from October 2003 through December 2008 and therefore considered the formula in its analysis of “other relevant matters” under the Lease valuation factors, as well as under “other reliable public sources of price or market information” in its alternative analysis of the 1988 regulatory factors. Id. at 227–39, 242–43. As the Director explained, the formula was the result of a neutral arbitration panel with full transparency into the basis for the formula price, whereas Hess’s other settlement agreements did not “provide any information on what was at issue, how the parties came to the formula price, or how that price pertains to Hess’s CO2 purchases or sales.” Id. at 236. Moreover, the arbitration panel set the formula price by blending two valuation methodologies based on expert testimony proffered by each of the parties, and the formula reflected “market conditions in the fall of 2003, [and] historical contracting practices.” Id. at 230–37. It was proper for the agency to rely on the Smithson formula, not for its precedential value, but rather for the relevant and reliable information it provided about Hess’s CO2 purchase contracts, pricing mechanisms, and historical contracting practices from this time. OXY also contends that the Director’s decision to consider ONRR’s valuation under the Lease valuation factors, instead of only the 1988 regulatory factors, 31 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 32 warrants reversal because this court’s affirmance “would inject substantial uncertainty to royalty valuation for thousands of similarly-situated federal oil and gas [standard-form] leases” and the 1988 regulations “cabin ONRR’s ability to substitute its own royalty value.” Aplt. Br. at 21–31; Aplt. Reply Br. at 4–5. But the Director’s decision was clear that it analyzed ONRR’s valuation in OXY’s case under the Lease valuation factors because the specific Bravo Dome Unit Agreement controlled: The Secretary “retained the right to establish a minimum value for federal CO2 production in the Unit in its approval of the [Bravo Dome] Unit Agreement,” which modified Hess’s underlying standard-form Leases to the extent they were inconsistent with the Unit Agreement. ROA, at 227–28, 424. The Director applied this same logic to reduce the pressure base calculation in accordance with the Unit Agreement in OXY’s favor, which OXY does not dispute. Id. at 247–48. Further, any such procedural inconsistency authorizing the Secretary to determine royalty valuation in the first instance in OXY’s case ultimately is irrelevant because (1) the Director reasonably articulated why the Unit Average is unreliable and (2) the Director independently analyzed ONRR’s valuation under the second regulatory benchmark in the alternative and came to the same conclusion. The Director also noted that while the Order had not explicitly mentioned the Lease valuation factors in its analysis of the second regulatory benchmark, the valuation factors overlapped, so the agency had thoroughly considered the Lease valuation factors in the process of analyzing the second regulatory benchmark. Id. at 228–38. 32 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 33 Because the Director weighed the relevant factors and evidence and adequately explained the agency’s decision, ONRR’s valuation is not arbitrary or capricious.
OXY next argues that the Director improperly rejected Hess’s Unit Average as the valuation method. OXY asserts that ONRR previously had approved the Unit Average, and while ONRR is not estopped from conducting audits or reexamining a valuation methodology, the Director’s decision and administrative record do not clearly support a reversal of the Unit Average. ONRR merely substituted its own methodology for the Unit Average “to extract more royalty dollars” without actually finding that the Unit Average was inconsistent with the regulations. Aplt. Br. at 17. OXY contends that ONRR instead should have conducted additional investigation into the pricing practices of other Unit entities before rejecting the Unit Average. Id. at 36–46. We conclude that the Director’s decision to reject the Unit Average valuation methodology is not arbitrary or capricious. In order for this court to reverse ONRR’s decision, we would have to conclude that the agency failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or failed to base its decision on consideration of the relevant factors. Utah Env’t Cong., 479 F.3d at 1280. The record presented does not support our reaching any of these conclusions in this case. ONRR provided a reasoned basis for rejecting the Unit Average price methodology under the applicable regulations. ROA, at 234–36. ONRR’s justifications collectively reinforce each 33 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 34 other: It was reasonable for ONRR to determine that the Unit Average—comprised primarily of non-federal lessees that are not subject to ONRR’s regulations or oversight mechanisms, that ONRR cannot audit, and that use valuation methodologies both largely unknown to ONRR and likely based at least in part on non-arm’s-length sales—was not an appropriate measure of value, particularly since the Unit Average resulted in a price lower than the Hess Purchase Contracts that ONRR was able to examine. The Director also explained in detail why any previous guidance or orders Hess received (namely 1980s-era correspondence between Amoco and the Minerals Management Service) that supported Hess using the Unit Average to calculate its royalties on its federal CO2 production were not germane. Id. at 248–53. As ONRR points out, none of the guidance OXY invokes had the force of law or was otherwise binding on the agency. Aple. Br. at 31–37. And even if OXY was correct that ONRR’s rejection of the Unit Average here conflicts with prior agency policy, nothing prevented ONRR from changing its position so long as it provided a reasonable explanation for doing so—and ONRR plainly provided a reasonable explanation for rejecting the Unit Average. The agency’s decision to reject the Unit Average is supported by substantial evidence and is not arbitrary or capricious.
OXY then argues that the Director misapplied the 1988 regulatory factors to alternatively affirm the agency’s valuation under the second regulatory benchmark. 34 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 35 Here, OXY’s challenge focuses on the district court’s analysis, rather than maintaining the required focus on the Director’s analysis under the APA. Aplt. Br. at 32–36. In affirming the Director’s alternative analysis under the 1988 regulatory factors, the district court stated that it “[would] not second-guess the Director’s decision in weighing the regulatory factors where the Director considered and analyzed the relevant factors and evidence.” ROA, at 87 (emphasis added). OXY takes issue with this statement because the district court “overlook[ed] the threshold point that the Director had no occasion to second-guess Hess’[s] valuation in the first instance.” Aplt. Br. at 35. OXY’s assertion is plainly wrong under the 1988 regulations, as well as the Unit Agreement and underlying Leases. Under the 1988 regulations, ONRR is required to audit the valuations that lessees supply and provide reasons for rejecting a lessee’s application of the regulatory benchmarks. 30 U.S.C. § 1711(c). Under the Unit Agreement and Leases, their terms dictate that ONRR retains the authority to establish a reasonable minimum valuation in accordance with the Lease valuation factors. ROA, at 442b, 446b, 450b, 454b [Sec. 2(d)(2)]. As demonstrated, ONRR did that here. Id. at 242–43. Moreover, we use ordinary APA deference principles to review the Director’s reasons for rejecting Hess’s Unit Average and approving ONRR’s valuation under the second regulatory benchmark. We cannot reweigh the regulatory factors if substantial evidence supports the Director’s reasoning—we cannot even displace ONRR’s choice “between two fairly conflicting views, even though the court would justifiably have made a different choice had the matter been 35 Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 36 before it de novo.” Wyo. Farm Bureau Fed’n, 199 F.3d at 1231 (internal citations omitted). Because the record reveals substantial evidence in support of the Director’s analysis of the regulatory valuation factors, the Director’s decision to alternatively affirm the agency’s valuation under the second regulatory benchmark is not arbitrary or capricious.