1. MARKETABLE CONDITION Bonnie Robson
Program Manager, Appeals & Regulations
Office of Natural Resources Revenue
PASO – February 2019

2. Disclaimer
The statements or opinions expressed in all ONRR presentations and panel discussions at the 2019 PASO-Tulsa Federal/Indian Royalty Compliance Workshop do not necessarily represent the views of ONRR or the Department of the Interior.

3. Overarching regulatory requirement
The lessee must place gas in marketable condition and market the gas for the mutual benefit of the lessee and the lessor at no cost to the Federal Government. 30 C.F.R. § (i) and .153(i) (federal gas), 30 C.F.R. § (h) (Indian gas).
Four elements of lessee’s obligation:
place in marketable condition
market
for mutual benefit
at no cost to lessor

4. Sources of more information about requirement
Authoritative sources include:
Lease, and potentially unit agreement or communitization agreement
Statutes
Regulations (including preambles to proposed and final rules)
Case law
Potentially helpful sources include:
ONRR dear reporter and dear payor letters
ONRR handbooks
ONRR unbundling or royalty valuation advice
ONRR employees
Conference materials and presentations
Potentially helpful sources do not bind ONRR or the lessee and are occasionally wrong

5. “Marketable condition” vs. “market” or “marketing”
Regulations define “marketable condition,” but not “market” or “marketing.”
For purposes of this discussion I use:
“marketable condition” to refer to physical condition
“marketing” to refer to selling or trading costs (transaction costs)
Preambles and case law often use “marketable condition” and “marketing” interchangeably in referring to physical condition.

6. Regulations define “marketable condition”
Marketable condition means “lease products which are sufficiently free from impurities and otherwise in a condition that they will be accepted by a purchaser under a sales contract typical for the field or area.” 30 C.F.R. § (federal gas), § (Indian gas).

7. What physical attributes or conditions?
For gas, we are usually referring to:
Pressure or compression
Water content or dehydration
Acid gas removal or sweetening
CO2 content
H2S content
Gathering is also discussed as part of a lessee’s obligation to market or place gas in marketable condition.

8. Regulation language specific to compression
Only two types of allowances: transportation and processing.
If compression is to be taken as a deduction, it must qualify as a transportation or processing expense.
Compression deductible as transportation?
Supplemental costs for compression are allowed only if such services are required for transportation and exceed the services necessary to place production into marketable condition. 30 C.F.R. § (f)(9) (federal gas), 30 C.F.R. § (f)(9) (Indian gas).
No allowance shall be made for boosting residue gas, except as provided in 30 CFR part C.F.R. § (b) (federal gas).
Compression deductible as processing?
Field processes, such as compression, are not processing. 30 C.F.R. § , definition of “processing” (federal gas), 30 C.F.R. § , definition of “processing” (Indian gas).
No processing cost deduction is allowed for the cost to place lease products in marketable condition, including compression, even if performed off the lease or at a processing plant (except where ONRR has approved an extraordinary cost allowance upon demonstration that the costs are, by reference to standard industry conditions and practice, extraordinary, unusual, or unconventional). 30 C.F.R. § (d) (federal gas).
Processing cost deductions will not be allowed to place lease products in marketable condition. These costs include compression upstream of the facility measurement point, even if performed off the lease or at a processing plant. 30 C.F.R. § (d) (Indian gas).

9. Regulation language specific to dehydration
Only two types of allowances: transportation and processing.
If compression is to be taken as a deduction, it must qualify as a transportation or processing expense.
Dehydration deductible as transportation?
Supplemental costs for dehydration are allowed only if such services are required for transportation and exceed the services necessary to place production into marketable condition. 30 C.F.R. § (f)(9) (federal gas), 30 C.F.R. § (f)(9) (Indian gas).
Dehydration deductible as processing?
Field processes, such as dehydration, are not processing. 30 C.F.R. § , definition of “processing” (federal gas), 30 C.F.R. § , definition of “processing (Indian gas).
No processing cost deduction is allowed for the cost to place lease products in marketable condition, including dehydration, even if performed off the lease or at a processing plant (except where ONRR has approved an extraordinary cost allowance upon demonstration that the costs are, by reference to standard industry conditions and practice, extraordinary, unusual, or unconventional). 30 C.F.R. § (d) (federal gas).
Processing cost deductions will not be allowed to place lease products in marketable condition. These costs include dehydration, even if performed off the lease or at a processing plant. 30 C.F.R. § (d) (Indian gas).

10. Regulation language specific to sweetening
Only two types of allowances: transportation and processing
If sweetening is to be taken as a deduction, it must qualify as a transportation or processing expense
Sweetening deductible as transportation?
No mention of sweetening or acid gas removal in transportation regulations.
Sweetening deductible as processing?
Field processes, such as sweetening, are not processing. 30 C.F.R. § , definition of “processing” (Indian gas).
Where gas is processed for the removal of acid gases, commonly referred to as ‘‘sweetening,’’ no processing cost deduction is allowed unless the acid gases removed are further processed into a gas plant product (except where ONRR has approved an extraordinary cost allowance upon demonstration that the costs are, by reference to standard industry conditions and practice, extraordinary, unusual, or unconventional). 30 C.F.R. § (d) (federal gas), 30 C.F.R. § (d) (Indian gas—no exception language).

11. Regulation language specific to gathering
A lessee may not deduct gathering costs. 30 C.F.R. § , definition of “allowance” (federal gas); 30 C.F.R. § (a) (Indian gas).
Gathering is defined by regulation as “the movement of lease production to a central accumulation and/or treatment point on the lease, unit, or communitized area, or to a central accumulation or treatment point off the lease, unit, or communitized area as approved by BLM or BSEE operations personnel for onshore and OCS leases, respectively.” 30 C.F.R. § (federal gas), § (Indian gas).
General rule of thumb: If its upstream of the royalty measurement point, its still gathering.
See preamble language at 53 FR 1184 at 1193 (January 15, 1988).

12. Regulation language specific to unbundling
The term “unbundling” is not used in ONRR regulations
But see:
allowances
marketable condition
market
gathering
dehydration
sweetening
compression
boosting

13. Case law support
The lessee must gather, dehydrate, and compress gas at no cost to the lessor. The Texas Co., 64 I.D. 76 (1957); California Co. v. Udall, 296 F.2d 384 (D.C. Cir. 1961); Devon Energy Corporation v. Kempthorne, 551 F.3d 1030 (D.C. Cir. 2008), cert. denied,130 S. Ct. 86 (2009).
The lessee must remove carbon dioxide (CO2) and sulphur (H2S) at no cost to the lessor. Apache Corp.,127 IBLA 125 (1993); Texaco, Inc. v. Quarterman, No. 96-CV-008J (D. Wyo. Aug. 20, 1996); Amoco Prod. Co. v. Watson, 410 F.3d 722, 725 (D.C. Cir. 2005), aff'd sub nom., BP Amoco Prod. Co. v. Burton, 549 U.S. 84 (2006).

14. Where do you find physical specs for marketable condition?
Trace the gas being valued for royalty purposes.
Generally, look to specs to enter the mainline pipeline at or after the tailgate of the processing plant.
A lessee arguing that its gas is in marketable condition at lesser specs further upstream carries the burden of proving that its gas was in a condition acceptable to arm’s-length purchasers under sales contracts typical for the field or area. Lessees most often fail to meet this burden or unsuccessfully attempt to shift the burden to ONRR.

15. Case law support
Marketable condition means gas treated so that it is marketable for delivery to the pipeline. Amoco, Devon, R.E. Yarbrough Co., 122 IBLA 217, 221 (1993), Shoshone, The Texas Co., J-W Operating Co.,159 IBLA 1 (2003).
If a lessee sells some gas that meets the definition of marketable condition for a particular market, that does not convert all gas sold into marketable condition. One must look to the market into which the gas at issue is sold to determine what marketable condition is for that gas. Amoco, Devon, Encana Oil and Gas, 185 IBLA 133 (2014), and Beartooth Oil and Gas Co. v. Lujan, No. CV BLG (D. Mont. 1993).
The fact that a purchaser agrees to accept untreated gas does not mean the gas was marketable in its natural state. In other words, the fact that you sell or transfer title at the wellhead does not mean the gas is in marketable condition at the wellhead. California Co., Amoco, and Devon.
Gas may be in marketable condition at the wellhead if there is a market at the wellhead evidenced by competing offers from multiple purchasers, the sales price is the same as that for gas that is compressed, and the pressure of the gas at the wellhead is adequate to gain access to the pipeline market. Xeno, Inc., 134 IBLA 172 (1995).

16. What if equipment serves multiple purposes?
Marketable condition trumps
While compression, dehydration, and removal of CO2 may serve to facilitate transportation or processing, once it is determined that such costs were incurred principally to place gas in marketable condition, those costs cannot also be the subject of a transportation or processing allowance. XTO Energy, 185 IBLA 219 (2015).
Lessees must offer affirmative evidence to support an assertion the costs of compression, dehydration, and treatment are not necessary to place the gas in marketable condition or that the gas was already marketable prior to compression, dehydration, and removal of acid gases. The burden rests on the lessee to demonstrate that these costs were not necessary to place the unprocessed gas in marketable condition and incurred only to transport and process its gas. Burlington Resources Oil & Gas Co., 183 IBLA 333, 352 (2013).

17. What if I don’t have information to break down a fee?
Get it, or don’t take the fee
ONRR is not required to comb a lessee’s records to determine if that lessee is entitled to a transportation allowance. Citation Oil & Gas v U.S. DOI, 448 Fed. Appx. 441, 445 (5th Cir. 2011).
It is the lessee’s burden to prove the gas is in marketable condition, not ONRR’s burden to prove that it is not. A lessee’s failure to secure information from third party service providers so that it may separate non-allowable expenses of putting gas in marketable condition from allowable transportation expenses is not an excuse. Devon Energy Production Company, L.P, ONRR O&G and O&G (Aug 21, 2015).

18. What if I deduct 100% of a fee anyway?
Yikes!
OIG and DOJ: Office of Inspector General and Department of Justice may investigate and sue under the False Claims Act, potentially leading to treble damages and debarment.
ONRR: Example: Lessee deducted, as transportation costs, the entire fee charged by a third party for gathering, compression, removal of acid gas, and dehydration services.
Lessee did not provide any affirmative evidence in support of its assertion that the costs of compression, dehydration, and removal of acid gas were not necessary to place the gas in marketable condition or that the gas was already in marketable condition prior to compression, dehydration, and removal of acid gas.
Director’s Decision held:
Lessee is responsible for the costs to gather, compress, remove acid gas, and dehydrate its gas to meet pipeline specification regardless of whether it performs those services or pays a third party to perform those services.
Lessee cannot deduct the entire service fee charged for compression, dehydration, and transportation when the fee includes costs to place the gas into marketable condition. Nor can it shift its responsibility to segregate allowable from unallowable costs to ONRR.
Once a lessee determines what is necessary to place the gas in marketable condition, it may segregate or “unbundle” the third party service fees and calculate an appropriate transportation allowance. Until such time, no transportation deduction is allowed.
Citation Oil & Gas Corporation, ONRR O&G (August 18, 2015)

19. What’s being appealed now? compression issues

20. Issues 1, 2, and 3: Recompression
Industry arguments:
If a lessee pays all costs of upstream compression, any booster compression through the same pressure range is deductible.
If a lessee pays all costs of booster compression, any upstream compression through the same pressure range is deductible.
If gas is at 100 psi at the royalty measurement point and marketable condition is 1000 psi, a lessee must pay all costs to compress gas 900 psi at the compressors of its choosing; all other compression is deductible.
ONRR position:
Moving from upstream to downstream, a lessee must pay all costs to compress gas up to the pressure that is marketable condition, and must also pay the costs to boost residue gas.
While the IBLA has recognized that 30 C.F.R. § (b)—which prohibits deduction of the costs of boosting—includes exception language, no lessee has identified and supported an exception in an appeal that has been decided.

21. Issue 1: Transportation losses

22. Issue 2: Processing losses

23. Issue 3: Booster recompression

24. Issues 4 and 5: Compression above marketable condition
ONRR position:
Compression for transportation before processing is deductible to the extent above the pressure that is marketable condition.
Compression of residue gas above marketable condition at or after a processing plant is not deductible, though the Director has yet to decide an appeal in which the lessee identified and supported a 30 C.F.R. Part 1206 exception to 30 C.F.R. § (b).
Industry argument:
Any compression for transportation or processing above the pressure that is marketable condition is deductible, regardless of whether it is before, at, or after a processing plant.

25. Issue 4: Compression above marketable condition before plant

26. Issue 5: Compression above marketable condition at or after plant

27. Issue 6: Compression for NGLs
Industry arguments:
The pressure requirement for residue gas to enter a mainline is not the pressure requirement for NGLs to enter an NGL pipeline, and should not set marketable condition requirements for NGLs.
Compression for transportation or processing of that portion of the unprocessed gas stream ultimately extracted as NGLs should be allowed where it raises pressure above the pressure required to enter the NGL pipeline.
ONRR position:
Issue not yet addressed in a Director decision or other case law.

28. Compression for NGLs