Opinion ID: 541820
Heading Depth: 3
Heading Rank: 1

Heading: Compression Costs in Manufacturing Allowance

Text: 17 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. Sec. 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. 18 Finally, the U.S. Geological Survey, the predecessor to the MMS, provides guidance in determining what ARCO manufacturing costs are deductible. 19 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 limited to those items which, in the judgment of the Supervisor, are an integral part of the extraction process. 20 Geological Survey, Conservation Division Manual, Part 647.7.3(D) (May 10, 1974) (CDM). 21 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. 22 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. 23 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. 24 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(D). Thus, that determination is left to the discretion of the Secretary. Second, the Secretary's regulation, found at 30 C.F.R. Sec. 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(D). 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. 25 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. 26 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, 65 S.Ct. 161, 164, 89 L.Ed. 124 (1944) (thorough, valid reasoning and consistency); Udall v. Tallman, 380 U.S. 1, 17-18, 85 S.Ct. 792, 801-02, 13 L.Ed.2d 616 (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 long-standing policy.