32 F.4th 1032
10th Cir.2022Background
- Bravo Dome Unit contains federal CO2 leases committed to a unit agreement approved by USGS; leases require at least 12.5% royalty and preserve the Secretary's right to establish minimum values using lease valuation factors.
- During the audit period Hess (later OXY) produced CO2 but sold only a de minimis amount; most CO2 was used by Hess in Permian Basin EOR operations or purchased from other unit owners for that use.
- Hess historically valued federal CO2 using a Unit Average (unit-operator net-back) and claimed compression/dehydration costs as a transportation allowance.
- ONRR (via a New Mexico audit) rejected the Unit Average as unverifiable, adopted a weighted-average approach for some periods and the Smithson arbitration formula for Oct 2003–Mar 2008, and disallowed the compression/dehydration deductions as costs of placing CO2 in marketable condition.
- ONRR’s Director largely affirmed the audit (adjusting the pressure-base calculation in Hess/OXY’s favor); the Interior Board did not issue a timely merits decision; the district court affirmed; the Tenth Circuit also affirms under APA review.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether ONRR reasonably established a minimum royalty value under the lease valuation factors | OXY: ONRR’s valuation is arbitrary; Smithson arbitration formula is irrelevant because it involved private leases and is not a market price; ONRR improperly displaced the Unit Average without adequate verification. | ONRR: Unit Average is unreliable/unverifiable (includes non‑federal and non‑arm’s‑length transactions); available reliable indicators were the Fasken arm’s‑length sale, Hess purchase contracts, and the Smithson formula for a subset of the period. | Court: Affirmed. ONRR considered relevant factors and evidence; reliance on weighted average and Smithson formula was reasonable and supported by substantial evidence. |
| Whether ONRR improperly rejected the Unit Average valuation | OXY: ONRR previously accepted or treated Unit Average as guidance; ONRR should have investigated unit parties’ pricing before rejecting it. | ONRR: Unit Average could not be audited/verified, likely included non‑arm’s‑length prices, and produced values lower than verifiable purchase contracts. | Court: Affirmed rejection. ONRR gave a reasoned explanation and substantial evidence supports the decision. |
| Whether ONRR misapplied the 1988 valuation regulations (second benchmark) in the alternative | OXY: Director had no occasion to second‑guess Hess’s valuation under the regs; agency substituted its own value improperly. | ONRR: Even under the 1988 regs, the same evidence (Fasken, Hess purchases, Smithson) supports ONRR’s valuation; ONRR properly audited and weighed benchmarks per regs. | Court: Affirmed. Director’s alternative analysis under the second benchmark was reasonable and supported by substantial evidence. |
| Whether compression and dehydration costs are deductible as a transportation allowance | OXY: CO2 is unique; compression/dehydration are essential primarily for transportation to remote EOR facilities and thus deductible. | ONRR: Those costs were required to place CO2 into marketable condition for the Permian EOR market (pressure/quality specs); costs are non‑deductible unless they both are required for transportation and exceed costs necessary to reach marketable condition. | Court: Affirmed. Agency’s marketable‑condition interpretation is reasonable; Hess/OXY did not show transportation costs exceeded marketable‑condition costs. |
Key Cases Cited
- Devon Energy Corp. v. Kempthorne, 551 F.3d 1030 (D.C. Cir. 2008) (compression/dehydration costs necessary to place gas in marketable condition are not deductible transportation costs)
- Amoco Prod. Co. v. Watson, 410 F.3d 722 (D.C. Cir. 2005) (applying marketable‑condition rule to deny certain transportation deductions)
- Amerada Hess Corp. v. Dep't of the Interior, 170 F.3d 1032 (10th Cir. 1999) (marketable‑condition principles in royalty valuation disputes)
- Mesa Operating Ltd. P'ship v. Dep't of the Interior, 931 F.2d 318 (5th Cir. 1991) (marketable‑condition concept limits transportation deductions)
- Utah Envtl. Cong. v. Troyer, 479 F.3d 1269 (10th Cir. 2007) (standards for arbitrary and capricious review)
- Wyo. Farm Bureau Fed'n v. Babbitt, 199 F.3d 1224 (10th Cir. 2000) (substantial‑evidence review does not permit reweighing conflicting evidence)