IBLA Upholds ONRR $3 Million+ Penalty For A Company’s Delay In Correcting Royalty Report Forms

A recent decision of the Interior Board of Land Appeals (IBLA) vividly makes the point that the Department of the Interior considers accurate royalty reporting to be equally if not more important than payment of the proper amounts. In Quinex Energy Corp., 192 IBLA 88 (2017), the operator underpaid royalties on several tribal and allotted leases covering lands on the Uintah and Ouray Indian Reservation in Utah in the amount of $120,242 because it used “erroneous gas prices.” The decision does not explain the reason for the erroneous prices but apparently the underpaid amount was promptly paid upon receipt of the Office of Natural Resources Revenue (ONRR) order to report and pay sent to Quinex. However, it took Quinex between 8 and 22 months to correct the royalty reports on the ONRR-2014 forms that it had filed relating to the royalty underpayments. The ONRR sent civil penalty notices to Quinex assessing penalties in the aggregate amount of $3,217,250 - more than 26 times the amount of the underpaid royalty! The penalty was assessed based on $25 per day for 229 reporting violations (one for each inaccurate line on the 2014 form) that continued for between 8 and 22 months.

The ONRR has statutory authority to assess civil penalties of up to $25,000 per day per violation for knowingly or willfully preparing, maintaining or submitting false, inaccurate, or misleading royalty reports. 30 U.S.C. § 1719(d). Under the Federal Civil Penalties Inflation Adjustment Act of 1990, that $25,000 statutory maximum is now $59,834 (30 C.F.R. § 1241.60(b)(2)). At the time of the events involved in the Quinex case, $25,000 was the maximum penalty, which ONRR reduced, in its discretion, based on the size of the payor (Quinex stated that it had five full-time and four part-time employees). Although there was no allegation that Quinex had behaved willfully, the IBLA stated that it did behave knowingly, because of the significant time between receipt of notice of the order to report and pay and final correction of the reports. The regulations define “knowingly or willfully” to include an act or failure to act committed with actual knowledge, deliberate ignorance, or reckless disregard of the facts surrounding the event or violation. 30 C.F.R. § 1241.3(b). No proof of specific intent to defraud is required as a condition to assessement of a civil penalty for knowing and willful violations of the regulations.

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Extension of Federal Oil and Gas Leases

Operators who do not regularly operate on federal lands may be surprised to discover that, unlike the typical private lands oil and gas lease, a federal lease does not contain a drilling operations clause that would extend the lease beyond the expiration of its primary term while drilling operations are being conducted. A recent decision of the Interior Board of Land Appeals (IBLA) drives home the importance of understanding exactly what facts are sufficient to extend a federal lease.

In Coastal Petroleum Company, 190 IBLA 347 (July 25, 2017), the IBLA upheld a decision of the Montana State Office of the Bureau of Land Management (BLM) which concluded that a lease had terminated at the end of its primary term because the lessee had not established that the well it had drilled and completed was capable of producing gas in paying quantities. Coastal’s lease would expire October 31, 2012. According to the decision, a well was spud prior to that date, the well was fracture treated on September 14, 2012, Coastal pulled two gas samples and determined that the well had good pressure and was able to flow on October 16, 2012, and Coastal received the gas analysis report on October 29, 2012. Based on these operations, Coastal concluded that at least two formations on the structure contained gas and that the well was capable of producing in paying quantities. But the BLM concluded that, without a flow test, BLM was unable to determine whether the amount of production would be of sufficient value to exceed operating costs; i.e., production in paying quantities. The IBLA agreed and noted that the burden is on the lessee to establish that a lease has been extended by a well capable of producing in paying quantities. The lesson for federal lessees is to plan operations that are intended to extend an expiring lease so that the well is completed for production and flow tested prior to the expiration date.

Another cautionary lesson from the Coastal decision is the need for a contingency plan in the event a well drilled near the end of the primary terms may not be completed as capable of producing in provable paying quantities prior to that date. Coastal argued in the alternative before the IBLA that it was engaged in testing and completing operations at the expiration of the primary term and so was entitled to a two-year extension of the lease under the "drilling over” provision of 30 U.S.C. §226(e). Coastal had not raised this argument in its request for State Director review of the BLM Field Office decision that the lease had terminated. It is not clear from the facts whether Coastal was actually conducting operations that would qualify as testing or completing under the regulation (43 C.F.R. §3100.0-5(g)) or whether Coastal had timely tendered the 11th year rental which is necessary in order to earn the drilling over extension. Instead, the IBLA refused to consider the argument at all because Coastal had not raised it before the State Director. The IBLA cited prior cases which establish that the Board will not consider issues raised for the first time on appeal except in extraordinary circumstances. The Coastal case appears to be a situation that easily could have been avoided by timing the drilling, completing and testing operations on the well to continue at the expiration of the primary term and by payment of the 11th year rental.

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