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New York Times: U.S. Drops Bid Over Royalties From Chevron

October 31, 2006

WASHINGTON, Oct. 30 — The Interior Department has dropped claims that the Chevron Corporation systematically underpaid the government for natural gas produced in the Gulf of Mexico, a decision that could allow energy companies to avoid paying hundreds of millions of dollars in royalties.

The agency had ordered Chevron to pay $6 million in additional royalties but could have sought tens of millions more had it prevailed. The decision also sets a precedent that could make it easier for oil and gas companies to lower the value of what they pump each year from federal property and thus their payments to the government.

Interior officials said on Friday that they had no choice but to drop their order to Chevron because a department appeals board had ruled against auditors in a separate case.

But state governments and private landowners have challenged the company over essentially the same practices and reached settlements in which the company has paid $70 million in additional royalties.

In a written statement, the department’s Minerals Management Service said it would have been useless to fight Chevron.

“It is not in the public interest to spend federal dollars pursuing claims that have little or no chance of success,” the agency said. “M.M.S. lost a contested and controversial issue” before the appeals board. “Had we simply wanted to capitulate to ‘big oil,’ the agency would not have issued the order in the first place.”

Chevron said in a written statement that it “endeavors to calculate and pay its oil and gas royalties correctly,” and it said that the Interior Department had agreed.

The agency notified Chevron of its decision in a confidential letter on Aug. 3, which The New York Times obtained recently under the Freedom of Information Act.

The reversal in the case, which involves Chevron’s accounting of natural gas sales to a company it partly owned, has renewed criticism that the Bush administration is reluctant to confront oil and gas companies and is lax in collecting royalties.

“The government is giving up without a fight,” said Richard T. Dorman, a lawyer representing private citizens suing Chevron over its federal royalty payments. “If this decision is left standing, it would result in the loss of tens of millions, if not hundreds of millions, of dollars in royalties owed by other companies.”

In return for the right to drill on federal lands and in federal waters, energy companies are required to pay the government a share of their proceeds. Last year, businesses producing natural gas paid $5.15 billion in government royalties.

But the Bush administration has come under fire on Capitol Hill for its record on collecting payments. While the Interior Department has sweetened incentives for exploration and pushed to open wilderness areas for drilling, it has also cut back on full-scale audits of companies intended to make sure they are paying their full share.

Administration officials knew that dozens of companies had incorrectly claimed exemptions from royalties since 2003, but they waited until December 2005 to send letters demanding about $500 million in repayments.

In February, the Interior Department acknowledged that oil companies could escape more than $7 billion in payments because of mistakes in leases signed in the 1990s. Top officials are trying to renegotiate those deals, but some Republicans and Democrats have complained that the administration is dragging its feet.

In addition, four government auditors last month publicly accused the Interior Department of blocking their efforts to recover more than $30 million from the Shell Oil Corporation, the Kerr-McGee Corporation and other major companies.

“This latest revelation proves that the Bush administration is incapable of preventing big oil companies from cheating taxpayers,” said Representative Edward J. Markey of Massachusetts, a senior Democrat on the House Committee on Resources. “The public has been systematically fleeced out of royalties that these companies owe for the privilege of drilling for oil and gas on lands belonging to all of us.”

The Chevron case offers a glimpse into what is normally a secretive process. To protect what energy companies consider proprietary information, the Interior Department does not announce that it is accusing companies of underpaying royalties nor does it announce its settlements in these disputes. The government also does not disclose how much money each company pays in royalties.

In theory, companies are required to pay the government a royalty of 12 percent to 16 percent of their sales. In practice, the definition of sales is as convoluted as a Rubik’s Cube.

In the Chevron case, auditors in the Minerals Management Service were addressing an issue that had bedeviled royalty enforcement for decades: How does the government make sure it gets its due when companies sell natural gas to businesses they partly own?

In 1996, Chevron sold its holdings in more than 50 processing plants to Dynegy in exchange for a 26 percent stake in the natural gas company, which is based in Houston. For the next seven years, Chevron sold virtually all its domestic natural gas to Dynegy for processing.

In their original accusations, dating to 2001, the auditors asserted that Chevron had understated sales, and hence its royalty obligations, by inflating costs for processing gas at Dynegy.

Companies are allowed to deduct processing costs from their sales revenues when they calculate their royalty obligations. Processing involves separating water and a variety of liquid fuels like propane and methane from raw natural gas. The auditors’ accusations were not unique. State officials in New Mexico challenged Chevron over the same issue — “non-arms-length” deals, as regulators call them — and Chevron agreed to pay $10.4 million in extra royalties without admitting wrongdoing. Private property owners who leased land to Chevron sued over the same issue in Oklahoma, and the company paid $60 million last year to settle out of court.

“The natural gas processing business lends itself almost uniquely to chicanery,” said Spencer Hosie, a lawyer who has represented the states of Louisiana and Alaska in several court fights over oil and gas royalties. “It is a complicated and opaque business, and there are many opportunities to shade judgments and numbers.”

From 2001 to 2003, after detailed audits of several Chevron leases, the Interior Department said the company was reducing its “sales value” by exaggerating processing costs at six of Dynegy’s many plants. At one plant, auditors estimated Chevron had claimed five times the actual costs.

At first glance, the suspected underpayments seemed trivial: about $6 million out of hundreds of millions in royalties. But the audits were limited to only a handful of plants. Had the Interior Department pressed its claims successfully, it could have recovered money tied to all the other plants, and for other years.

Chevron paid the $6 million but appealed. The file in that case now runs more than 900 pages, most of it still off-limits to the public.

Mr. Hosie, who represented Louisiana in a lawsuit that led to a $100 million verdict against Chevron over underpaid oil royalties, expressed surprise at the federal government’s decision in the natural gas case.

“Is it even remotely likely that oil companies systematically underpay private royalty owners and state governments, but pay the federal government perfectly properly?” Mr. Hosie asked. “Isn’t it more likely they are underpaying everybody?”

A Chevron spokesman, Donald Campbell, said laws regulating state and private leases often differed significantly from those of the federal government. “The rules governing valuation vary from jurisdiction to jurisdiction,” Mr. Campbell said in a statement.

Chevron argued that New Mexico’s rules presumed that a deal was “not at arms length” — and that costs had to be calculated differently — if one company owned 10 percent to 50 percent of the other. The federal regulations, Chevron said, required auditors to consider additional factors before making such a determination. Because of a backlog, the appeals board had not considered Chevron’s appeal when Interior Department officials decided they could not win. But if the appeals board had overruled the auditors, federal regulations would have allowed the interior secretary to let a federal court decide the issue.

In their letter to Chevron, department officials did not say the underlying facts had changed. Rather, they noted that the agency’s Board of Land Appeals had rejected similar accusations about non-arm’s-length agreements involving two other companies, Vastar Resources and Southern Companies.

The appeals board ruled in 2005 that the Minerals Management Service had failed to show that Vastar had any real control over a partnership it had formed with Southern to sell its gas. The board said Vastar had provided “uncontroverted evidence” that the sales prices had been negotiated at arm’s length between companies with “opposing economic interests.”

But the Chevron case differed in several important ways.

The government never audited Vastar in reaching its conclusions and had provided a largely theoretical opinion when the company asked for guidance. By contrast, auditors had scrutinized Chevron, which is based in San Ramon, Calif., and Dynegy and backed their arguments with supporting data.

Chevron’s ties with Dynegy also appeared to be closer than those between the other companies. Chevron described Dynegy as an affiliate in some reports to shareholders. Chevron was also Dynegy’s biggest supplier of raw natural gas, its biggest customer for gas processing and one of its biggest for processing byproducts like propane and methane.

Administration officials said they had “carefully reviewed” similarities and differences between the cases, but offered little elaboration.

“We recognize that other parties may assert various arguments regarding the relationship between the Vastar and Chevron situations,” the Minerals Management Service said in its written response to questions, “but the agency’s evaluation and deliberative processes are privileged.”

John Bemis, the assistant commissioner for gas and minerals in New Mexico, said his state was challenging a growing number of such alliances. In addition to the $10.4 million royalty settlement with Chevron, New Mexico persuaded ConocoPhillips to settle a similar case in August for $9.5 million and is negotiating with BP in a third case.

Interior Department officials have shown little interest in evidence from either New Mexico’s experience or a current court fight with Chevron over federal royalties.

On July 11, three weeks before the department dropped its case against Chevron, Mr. Dorman and other lawyers involved in a Texas lawsuit against Chevron wrote to Interior Department officials. The lawyers, who represent a whistle-blower seeking to recover money for the federal government, said they were suing Chevron over the same issues the department had raised.

“All we were saying was that they should wait to see what evidence we turned up, and that we would gladly share everything we had with them,” Mr. Dorman said. His firm faxed a letter to the policy appeals division. Getting no response, the lawyers sent a copy by U.P.S. Six days later, it was returned. The reason, according to the U.P.S. label: “Receiver did not want, refused delivery.”

The agency confirmed in a statement that it knew of the lawyers’ case. Asked why it refused to accept their letter, the Minerals Management Service said it could not comment “because these matters are the subject of pending litigation.”

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