When a company gets into the Exploration and Production business, there are usually several drivers. The potential for massive revenue is chief among them, but do they always think about the costs? Like any business, you don’t get into business to lose money so the costs must be weighed against the benefits. The E&P space is one of the most lucrative choices right now because the most recent price drop has caused more innovation in the market, making it easier to produce more at a lower cost. The costs of producing a well or lease are can be predicted, but what is not always foreseen is the regulation attached to certain lands. There are four types of lessors (mineral owner): Fee (not a government), State, Federal (US), and Tribal (Native American). Each Lessor type has its own set of regulations.
When you have Federal or Tribal leases, you are required to report a Form MMS-4054, which is the Oil and Gas Operations Report (OGOR). This form tells the Office of Natural Resources Revenue (ONRR) what your oil and gas production is, as well as water disposal for a given well for a particular month. If you operate a federal or tribal onshore or Outer Continental Shelf (OCS) lease or federally approved unit with wells that are not plugged and abandoned, you must report the OGOR. You must also submit a Form-2014, Report of Sales and Royalty Remittance, which as the name suggests will take that same production information from the OGOR and attach a royalty value to it. This royalty is then collected by the ONRR to keep if it is a federal lease or to distribute to the appropriate parties if it is non-federal.
Additional for Tribal Leases
Tribal leases have an additional form to be filled out in Form-4410, Accounting for Comparison (Dual Accounting) and Form-4411, Safety Net Report. Form-4410 is the election to use or not use Dual Accounting. Dual Accounting is taking the greater of these two values: value of gas prior to processing less any allowances and combined value of residue, gas plants products, drip condensate associated with the processed gas recovered downstream of the royalty settlement point less allowances. Form-4411 is for when gas production from a tribal lease is sold beyond the first index price point. Its purpose is to create a minimum value for the tribal leases the lessee (Company) is responsible for reporting and paying (Forms and Reports, 2010).
Index Zone valuation is found by taking the average of the highest reported prices for all index pricing points in an index zone from each ONRR-approved publication, sum the averages, divide by number of publications, and then reduce the number by 10%. The reduction can be not less than $0.10/mmbtu or more than $0.30/mmbtu.
Residue and unprocessed gas
Residue and unprocessed gas produced in an index zone that either has a major portion provision or provides the Secretary the ability to determine the value of production are valued in one of two ways depending on if the contract is an arm’s-length or non-arms’ length contract. Arm’s length contracts are valued at the higher of the index zone price or the gross proceeds price. Non-arm’s length contracts are valued at the index zone price unless the gas was subject to a previous contract which was part of a gas contract settlement.
Processed gas must be valued at the higher of two values: the value before processing and the value after processing which is the sum of residue gas, NGLs, and drip condensate value (Product Valuation, 2010).
Arm’s Length Contract
The higher of the gross proceeds minus allowances and the index price (IBMP) value is the value reported for oil in an arm’s length contract. If there are multiple contracts for a lease then you calculate the volume-weighted average value and compare to the IBMP. The burden is on the reporter to proof an arm’s length relationship. If you or your affiliate exchange oil at arm’s length for WTI or equivalent oil at Cushing, Oklahoma, you must value the oil at New York Mercantile Exchange (NYMEX) minus differentials. If you do not exchange for WTI or equivalent at Cushing, Oklahoma, you must value using gross proceeds minus allowances.
Non-Arm’s length contracts are valued at the higher of the gross proceeds minus allowances and the IBMP price. The difference between Arm’s length and Non-Arm’s length is the Non-Arm’s length is a volume-weighted average of gross proceeds minus allowances. If there are purchases of oil outside of the field and cannot calculate a price, the volume cannot be included in the weighted average. Before calculating the volume-weighted average, you must normalize the quality of the oil to the same gravity as the oil produced from the lease.
Major Portion Provision
You must report the higher of the IBMP or gross proceeds every month. ONRR will look at the volume data report two months prior to the current production month to determine if the Location and Crude Type Differential (LCTD) needs to be modified. If monthly oil sales volumes not reported under Sales Type Code OINX is outside of 3% either way of 25% of the total volumes reported, the LCTD will be adjusted accordingly. If the volumes fall below 22%, then the LCTD will be raise 10% every month until the variance is back within 3%.
The lessor is required to put both oil and gas products in a condition that they could be sold at no cost to the federal/tribal government which means you have to add deducts back in for processes that put the products sold into a condition to be sold (Product Valuation, 2010).
ONRR has two different ways of checking on the correctness of the reports that are submitted. They have an Audit of records and a Lease account reconciliation. The audit of records to make sure what you have reported can be proven and to make sure the 2014 and the OGOR have the same volume information. Lease account reconciliations are performed when a tribe identifies a lease as potentially having significant underpayment (Audits, 2010).
There is a formal process for receiving civil penalties set up with the Federal Oil and Gas Royalty Management Act of 1982 (FOGRAMA) which gave the Secretary of Interior the ability to manage and collect royalties on federal and tribal lands. There are three different notices that can be sent from ONRR to a reporter: Notice of Noncompliance (NONC), Failure to Correct Civil Penalty Notice (FCCP), and Immediate Liability Civil Penalty Notice (IFCP).
Notice of Noncompliance
The NONC identifies the violation, gives the corrective action and a specific timeframe to make the corrections in to avoid penalty. You have 20 days to make corrections upon the day you receive the notice unless a longer period is specified in the notice. If you make the necessary corrections within the 20 days, no civil penalty will be assessed, but it does stay on your record to be used as your history of noncompliance for any future noncompliance.
Failure to Correct Civil Penalty Notice
The FCCP is the penalty assessed when corrections are not made within the timeframe given on the NONC. The penalty starts accruing the day you receive the NONC and will continue to accrue until the corrections are made. The penalty is up to $1,273 per day per violation identified for up to 40 days after NONC is received. After 40 days, the penalty goes up to a maximum of $12,740 per day per violation if not corrected.
Immediate Liability Civil Penalty Notice
IFCP identifies the violation and a penalty even if you have not been given previous notice and an opportunity to correct the violation. The amount of civil penalty begins running on the day the violation is committed. The penalty begins at $25,479 per day per violation if you are found to have failed to make payments in a timely manner or refused entry for inspection or audit.
The penalty begins at $63,699 per day per violation if you are found to have knowingly or willfully prepared, maintained, or submitted false, inaccurate, or misleading reports, notices, affidavits, records, data, or any other written information.
Any information may be used as evidence of knowingly or willfully committing a violation including emails, lack of appeal, or repeat offenses.
These notices are sent out by registered mail or personal service to the addressee of record. The notice is considered served when the notice is delivered to the addressee of record. You must request a hearing in a timely manner. You can request a hearing on a NONC to contest liability, a FCCP to contest only the amount of the penalty, and an ILCP to contest liability, amount owed, or both. A hearing can also be called even if the corrections from the notice have been made.
ONRR assesses penalties based on the following criteria:
- Severity of noncompliance
- History of noncompliance
- Size of business (Number of employees in company, parent company or companies, or subsidiaries)
- Royalty consequences of underlying violation not considered
- FCCP and ILCP assessment matrices and adjustments are on ONRR website
- Penalty is in addition to interest of underlying underpayment
- Interest also due on penalty if not paid by due date
McGirt SCOTUS Decision
On July 9, 2020, the U.S Supreme Court held that the land reserved for the Creek Nation remains “Indian Country” for the purposes of the Major Crimes Act (MCA) in McGirt v. Oklahoma. The background of McGirt v. Oklahoma is that in 2020, Jimcy McGirt challenged the state’s jurisdiction in a case against him from 1996. He argued he is entitled to a new trial in federal court. The U.S Supreme Court held that once Congress established a federal reservation, only Congress can disestablish it and they have not done so. Because of this finding, they ruled Oklahoma did lack jurisdiction to prosecute Mr. McGirt.
On its face, this ruling is confined to criminal cases, but if other Native Nations decide to challenge their standing as “Indian Country” for the purposes of the MCA, they would gain some civil jurisdictions that would allow them to tax any business on their land regardless of if it run by a non-native or not. This would not take away the taxes paid to the state so this could result in dual taxation. Other possible implications could be additional regulations in the form of limiting access to water lying within the boundaries of the tribal nation and the tribal nation seeking federal environmental regulations instead of the more relaxed state regulations by applying for the U.S. Environmental Protection Agency for Treatment as a State (TAS) status. Approval of this application would mean the tribal nations could impose more stringent standard than required by federal law (Wayne, et al., 2020).
How Can PetroLedger Financial Services Help?
PetroLedger Financial Services provides oil and gas industry expertise to back-office support. Whether you have one lease or maybe thousands, PetroLedger has your regulatory compliance needs well in hand. We have 25 plus years’ experience in state, federal and tribal reporting. From production volume reporting, to state severance taxes, to ONRR reporting, we can ensure timely and accurate reporting. We have experience in state royalty reporting, escheatment, as well as an understanding of the environmental, legal, and safety regulations that apply within the Oil & Gas Industry.
When you partner with PetroLedger, we take the time to understand your business and fully review your filing history. We believe that managing compliance properly from the beginning will lead to efficiencies and cost-savings down the road. Interested? Contact us today!