Unintentional Misconduct and Standardless Discretion: The Department of Interior’s New Rules for Valuing Oil, Gas and Coal

The Office of Natural Resources Revenue (ONRR) within the Department of the Interior issued new royalty valuation rules on July 1, 2016. Although the goal of the regulations is to simplify the calculation of royalties on federal oil, gas and coal, the 65 pages of rules please no one. Under a new definition for “misconduct,” normally considered to require some degree of intent, misconduct now “means any failure to perform a duty owed to the United States under a statute, regulation, or lease, or unlawful or improper behavior, regardless of the mental state of the lessee or any individual employed by or associated with the lessee.” 30 C.F.R. § 1206.20. Although ONRR can pursue civil penalties only if the misconduct is intentional, in the case of unintentional misconduct connected with a royalty valuation, such as a simple reporting error, ONRR can impose its own valuation.

ONRR has also added a controversial default provision allowing ONRR to substitute its own oil valuation for that reported by a lessee based on actual arm’s-length contracts. Decried by industry as “standardless” ONRR discretion and “second-guessing of arm’s-length contracts,” the provision lacks specific criteria for determining what is a reasonable valuation and gives ONRR the power to impose its own valuation based on “any information we deem relevant.” 30 C.F.R. §§ 1206.101 and 1206.105. Many companies are concerned that the lack of specific criteria for valuation will create uncertainty and act to discourage development of federal minerals.

While industry is not pleased with the new rules, neither is the environmental community, which submitted over 190,000 petition signatures during the public comment period urging the government to “keep it in the ground.” ONRR declined to act, however, stating that a decision to halt federal fossil fuel production was beyond the scope of this rulemaking.

The Final Rule, which takes effect on January 1, 2017, may be found here.