United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued December 5, 2001 Decided February 8, 2002
No. 00-5404
Independent Petroleum Association of America,
Appellee
v.
Wallace P. DeWitt,
Acting Assistant Secretary,
for Land and Minerals Management, DOI and
United States Department of the Interior,
Appellants
Consolidated with
00-5405
Appeals from the United States District Court
for the District of Columbia
(No. 98cv00531)
(No. 98cv00631)
---------
Sean H. Donahue, Attorney, U.S. Department of Justice,
argued the cause for appellants. With him on the brief were
John C. Cruden, Acting Assistant Attorney General, William
B. Lazarus and John A. Bryson, Attorneys.
Jill Elise Grant, Harry R. Sachse, and James E. Glaze
were on the brief for amici curiae Southern Ute Indian Tribe
and Jicarilla Apache Nation.
Lee Ellen Helfrich was on the brief for amicus curiae
California State Controller.
L. Poe Leggette argued the cause for appellee Independent
Petroleum Association of America. With him on the brief
was Nancy L. Pell.
Thomas J. Eastment argued the cause for appellee Ameri-
can Petroleum Institute. With him on the brief was David T.
Deal.
John K. McDonald and Harold P. Quinn Jr. were on the
brief for amicus curiae National Mining Association.
Before: Sentelle and Rogers, Circuit Judges, and
Williams, Senior Circuit Judge.
Opinion for the Court filed by Senior Circuit Judge
Williams.
Concurring opinion filed by Circuit Judge Sentelle.
Williams, Senior Circuit Judge: Producers of natural gas
typically lease the mineral rights and compensate the owner
by means of a royalty calculated as some fraction (such as 1/8
or 1/6) of the value of the gas produced. In exchange, lessees
agree to bear the costs and risks of exploration and produc-
tion. Federal and Indian gas leases are no exception.
But the federal government is not your standard oil-and-
gas lessor. For the detailed ascertainment of the parties'
rights, its leases give controlling effect not merely to extant
Department of Interior regulations but also to ones "hereaf-
ter promulgated." See, e.g., Department of Interior, Form
3100-11, at p. 1 (1992). The regulations have historically
called for calculation of royalty on the basis of "gross pro-
ceeds." See, e.g., 30 C.F.R. ss 206.152(h) (federal unpro-
cessed gas), 206.153(h) (federal processed gas). But to abide
by the statutory mandate to base royalty on the "value of the
production removed or sold from the lease," 30 U.S.C.
s 226(b)(1)(A), Interior has allowed two deductions from
gross proceeds when calculating value for royalty purposes.
One deduction relates to certain processing costs and is
irrelevant here; the other is for transportation costs when
production is sold at a market away from the lease. 30
C.F.R. ss 206.157, 206.177; see also Final Rule, Revision of
Oil Product Valuation Regulations and Related Topics, 53
Fed. Reg. 1184, 1186 (1988). These are evidently the only
deductions from gross proceeds. Walter Oil & Gas Corp.,
111 IBLA 260, 265 (1989). Marketing costs have therefore
not been deductible. See, e.g., Arco Oil & Gas Co., 112 IBLA
8, 10-11 (1989).
In the mid-1980s a series of rulemakings by the Federal
Energy Regulatory Commission somewhat changed the cir-
cumstances to which these principles applied. Previously,
producers most commonly sold gas at the wellhead to natural
gas pipeline companies, which then transported it and sold it
to local distribution companies; less commonly, they made
direct sales from producer to an end user or distributor, with
the pipeline providing only transportation. See, e.g., FPC v.
Transcontinental Gas Pipeline Corp., 365 U.S. 1, 4 (1961).
But FERC, starting with Order No. 436 and culminating in
Order No. 636, in effect transformed the pipelines into "open-
access" transporters and required them to separate sales
from transportation services, Final Rule, Pipeline Service
Obligations and Revisions to Regulations Governing Self-
Implementing Transportation, and Regulation of Natural
Gas Pipelines After Partial Wellhead Decontrol, 57 Fed. Reg.
13,267, 13,279/1 (1992) ("Order 636"), to charge unbundled
rates for services such as transmission and storage, id. at
13,288-89, and to assign their merchant services to functional-
ly independent market affiliates, id. at 13,298; see also 18
C.F.R. s 161 (1988) (restricting pipelines from favoring such
affiliates). In effect, the pipelines as such became almost
exclusively transporters of gas, and direct sales by producers
to end users, distributors, or merchants became the norm.
In response to these changes, the Department of Interior
in 1997 amended its gas royalty regulations "to clarify [its]
existing policies" and to prevent lessees from claiming "im-
proper deductions on their royalty reports and payments."
Final Rule, Amendments to Transportation Allowance Regu-
lations for Federal and Indian Leases to Specify Allowable
Costs and Related Amendments to Gas Valuation Regula-
tions, 62 Fed. Reg. 65,753/3-65,754/1 (1997) ("Final Rule").
Two trade associations representing the gas producers
(American Petroleum Institute for the "majors," Independent
Petroleum Association of America for the "independents")
brought suits challenging these regulations as arbitrary and
capricious. Their primary contention was that Interior had
impermissibly refused to permit deductions for costs incurred
in marketing gas to markets "downstream" of the wellhead.
Dispute focused especially on Interior's denial of deductions
for (1) fees incurred in aggregating and marketing gas with
respect to downstream sales; (2) "intra-hub transfer fees"
charged by pipelines for assuring correct attribution of quan-
tities to particular transactions (not for the physical transfers
themselves); and (3) any "unused" pipeline demand charge
(i.e., the portion of a demand charge paid to secure firm
service but relating to quantities in excess of a producer's
actual shipments).
The district court granted summary judgment for the
producers in broad terms, Independent Petroleum Associa-
tion of America v. Armstrong, 91 F. Supp. 2d 117, 130
(D.D.C. 2000) ("IPAA"), but then granted Interior's Rule
59(e) motion for clarification, Independent Petroleum Associ-
ation of America v. Armstrong, No. 98-00531(RCL) (D.D.C.
Sept. 1, 2000) ("Amended Order") (unpublished opinion).
When the dust had settled, the upshot was to declare that the
relevant regulations were unlawful "to the extent that they
impose a duty on lessees to market gas downstream ... and
disallow the deduction of downstream marketing costs," in-
cluding the intra-hub transfer fees, and to the extent that
they limit deduction for firm demand charges to the applica-
ble rate multiplied by the "actual volumes transported."
Amended Order, slip op. at 2. The modified order also
specified that a producer that sold unused pipeline capacity
must credit the United States with the resulting revenue. Id.
Interior now appeals.
We review the district court's ruling de novo, "as if the
[agency's] decision had been appealed to this court directly."
Kosanke v. Dep't of Interior, 144 F.3d 873, 876 (D.C. Cir.
1998) (quoting Dr. Pepper/Seven-Up Cos. v. FTC, 991 F.2d
859, 862 (D.C. Cir. 1993)). On the deductibility of marketing
costs we find no legal error in Interior's rule and therefore
reverse the district court; on the "unused" demand charge
issue, we affirm the district court.
* * *
The producers argue that we owe no deference to Interior's
judgments here, saying that the case involves interpretation
of contracts, not of a statute. Thus they call for "interpreta-
tion under neutral principles of contract law, not the deferen-
tial principles of regulatory interpretation." Mesa Air
Group, Inc. v. Department of Transportation, 87 F.3d 498,
503 (D.C. Cir. 1996). But see National Fuel Gas Supply
Corp. v. FERC, 811 F.2d 1563, 1570-71 (D.C. Cir. 1987)
(applying a Chevron framework to agency interpretation of
contracts, though expressing concern where the agency is
self-interested). Thus the producers' briefs point (rather
summarily) to state court decisions, implicitly asking us to
treat the matter as would a state court interpreting private
leases. But here the contracts themselves lead us back to the
agency. As we said, they incorporate the regulations and
recognize Interior's authority to modify them. E.g., Form
3100-11, at p. 1 ("Rights granted are subject ... to regula-
tions and formal orders hereafter promulgated when not
inconsistent with lease rights granted or specific provisions of
this lease."); id. at s 2 (reserving to Interior "the right to
establish reasonable minimum values on products"); see also,
e.g., Department of Interior, Form MMS-2005, s 6(b) (1986);
Department of Interior, Form BAO-436A, s 3 (1993).
Of course the application of new rules to pre-existing leases
may involve "secondary retroactivity": a new rule that legally
has only "future effect," and is therefore not subject to
doctrines limiting retroactive effect, may still have a serious
impact on pre-existing transactions. See, e.g., Bowen v.
Georgetown University Hospital, 488 U.S. 204, 219-20 (1988)
(Scalia, J., concurring). Interior's own rules recognize the
possibility, explicitly repudiating any authority to alter the
royalty rate except downwards (i.e., in the lessee's favor). 30
C.F.R. s 202.52(a). The legal effect of such secondary retro-
activity is to add a nuance to ordinary review for whether the
agency has been arbitrary or capricious: we review to see
whether disputed rules are "reasonable, both in substance
and in being made retroactive." U.S. Airwaves, Inc. v. FCC,
232 F.3d 227, 233 (D.C. Cir. 2000). But this added nuance is
quite different from a general denial of deference.
In a related argument, producers urge that deference to
Interior's interpretation of the statute under Chevron U.S.A.,
Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837
(1984), is inappropriate for regulations that affect contracts in
which Interior has financial interests.
But in the mineral leasing statutes Congress has granted
rather sweeping authority "to prescribe necessary and proper
rules and regulations and to do any and all things necessary
to carry out and accomplish the purposes of [the leasing
statutes]." 30 U.S.C. s 189 (federal lands); see also 25
U.S.C. ss 396, 396d (tribal lands); 43 U.S.C. s 1334(a) (outer
Continental shelf). These "purposes," of course, include the
administration of federal leases, which involves collecting
royalties and determining the methods by which they are
calculated. See California Co. v. Udall, 296 F.2d 384, 387-88
(D.C. Cir. 1961); see also Independent Petroleum Association
v. Babbitt, 92 F.3d 1248, 1262 n.6 (D.C. Cir. 1996) (Rogers, J.,
dissenting) (recognizing that Congress authorized Interior "to
prescribe regulations governing mineral leases").
It is thus not surprising that the cases do not support
producers' theory. Though no circuit appears ever to have
ruled specifically on the issue of deference to financially self-
interested agencies, courts have regularly applied Chevron in
royalty cases. In California Co., we deferred to Interior's
interpretation of the word "production" for purposes of calcu-
lating royalty, noting the Department's duties both to protect
the public interest in royalties and to assure "incentive[s] for
development." 296 F.2d at 388. Similarly, in Mesa Operat-
ing Limited Partnership v. Department of Interior, 931 F.2d
318 (5th Cir. 1991), the Fifth Circuit applied Chevron in
determining whether certain reimbursements were subject to
royalty. Id. at 322; see also Enron Oil & Gas Co. v. Lujan,
978 F.2d 212, 215 (5th Cir. 1992) (applying Chevron to issue of
whether state tax reimbursements are subject to royalty);
Marathon Oil Co. v. United States, 807 F.2d 759, 765-66 (9th
Cir. 1986) (applying Chevron to Interior's use of a "net-back"
method for calculating value for royalty purposes). Our
reference in California Co. to Interior's necessary concern for
producer incentives in effect invoked Interior's role as a
repeat player, which would cause Interior to pay severely if it
acquired a reputation for pulling the rug out from under the
generally accepted meaning of existing leases.
In support of their position, producers principally rely on
language from Transohio Savings Bank v. Office of Thrift
Supervision, 967 F.2d 598 (D.C. Cir. 1992), where we ex-
pressed reluctance to apply Chevron "to an agency interpre-
tation of a statute that will affect agreements to which the
agency is party." Id. at 614. But we ultimately found that
Congress's intent was clear and thus had no occasion to grant
(or withhold) deference. See id. at 614-15. In the end, of
course, the availability of Chevron deference depends on
congressional intent, but our application of such deference in
the face of a recognized risk of agency self-aggrandizement,
such as interpretations of their own jurisdictional limits,
Oklahoma Natural Gas Co. v. FERC, 28 F.3d 1281, 1283-84
(D.C. Cir. 1994), necessarily means that self-interest alone
gives rise to no automatic rebuttal of deference. Indeed,
given the ubiquity of some form of agency self-interest, see
generally Dennis C. Mueller, Public Choice 156-70 (1979);
William A. Niskanen, Jr., Bureaucracy and Representative
Government (1971), a general withdrawal of deference on the
basis of agency self-interest might come close to overruling
Chevron, a decision far beyond our authority. We see no
indication here of a special intent to withhold deference.
* * *
"Downstream" marketing costs and intra-hub transfer
fees. We find nothing unreasonable in Interior's refusal to
allow deductions for so-called "downstream" marketing costs.
See Final Rule, 62 Fed. Reg. at 65,756. Both the producer
groups acknowledge that marketing costs for sales at the
lease have historically been nondeductible. API Br. at 30;
IPAA Br. at 22. Yet at no point do they offer a persuasive
reason for introducing a distinction between marketing for
leasehold sales and for "downstream" sales. Indeed, market-
ing does not even appear readily divisible between the two, as
it would be if lessees stood on their lease boundaries and
operated the equivalent of a lemonade stand for leasehold
sales, but traveled to distant cities for "downstream" ones.
Rather, so far as it appears, marketing proceeds by means of
the standard modern devices--face-to-face meeting, phone
call, internet posting. See, e.g., Order 636, 57 Fed. Reg. at
13,282/2 (describing electronic bulletin boards, then precur-
sors to the Internet, as having become "standard industry-
wide practice"). Unlike the sale itself, which will presumably
involve shifts of title and possession at specified points,
marketing has no locus--certainly none that ineluctably
tracks the point where title shifts.
To be sure, transaction costs may be higher for sales in the
current market; sales to a single (perhaps monopsonistic)
pipeline may have been painfully simple. But a change in the
dimension of a cost is hardly an argument for its reclassifica-
tion, as the Interior Board of Land Appeals has observed.
Arco, 112 IBLA at 11. And because the producers are under
no duty to market "downstream" and may opt to sell at the
leasehold, see IPAA, 91 F. Supp. 2d at 123 ("Interior con-
cedes that plaintiffs are free to sell or beneficially consume
gas at the wellhead only, rather than pursue downstream
sales."), a complaint based on the cost change is especially
weak.
Producers further argue that downstream marketing adds
to the value of the gas at the leasehold, and thus that the
royalty owner should share the costs. In support, they
propose what amounts to an elegant theory suggesting that
the sale of "marketable condition" gas at the leasehold repre-
sents a baseline, and that the costs of all further value-adding
activities should be deductible. Under this view, producers
explicitly condemn any distinction between marketing and
transportation. But the argument in the end seems almost
metaphysical; it is a claim that when the maximum value of
gas can be realized by a downstream sale, then not only
transportation costs but also the cost of efforts undertaken to
identify and realize that value must somehow be more like
transportation itself than they are like on-lease marketing.
Assuming arguendo that producers' metaphysical point is
correct, we think it falls far short of compelling the Depart-
ment to give up its usual distinction between marketing and
transporting costs. Not only is the distinction traditional,
Walter Oil, 111 IBLA at 265, but Interior has historically
applied it to downstream sales, denying deductibility for a
lessee's costs in hiring a marketing agent to arrange trans-
portation downstream, to aggregate customers, and to deal
with a local distribution company. Arco, 112 IBLA at 9-12.
Given the difficulty in slicing up marketing costs on the basis
of the point of sale, and given that Interior must take
administrability into account, compare Owen L. Anderson,
"Royalty Valuation: Should Royalty Obligations Be Deter-
mined Intrinsically, Theoretically, or Realistically? (Part 2),"
37 Nat. Resources J. 611, 678 (1997) (discussing monitoring
problems), we find nothing unreasonable in its hewing to the
old line between marketing and transportation.
The producers' attack on Interior's denial of deductibility
for aggregator/marketer fees, 30 C.F.R. ss 206.157(g)(2),
206.177(g)(2), rests on the same foundations as the more
general attack on "downstream" marketing costs and there-
fore fails for the same reasons. Intra-hub transfer fees, id.
at ss 206.157(g)(4), 206.177(g)(4), are slightly different. As
IPAA recognizes, intra-hub transfer fees are charged "when
[a] lessee sells the gas at [the] pipeline's junction at the hub."
IPAA Br. at 30 (emphasis added). Interior distinguishes
these fees, which are part of a "sales transaction," from so-
called intra-hub wheeling fees, which are charged for the
actual transportation of gas through a hub. See Final Rule,
62 Fed. Reg. at 65758. Producers contend that Interior
allowed deduction for these costs in the past and failed to
justify its change in policy. Before FERC Order No. 636,
costs of this sort, even though reasonably classifiable as
marketing, would have been bundled with transportation
costs, making precise separation administratively trouble-
some, if not impossible. Once Order No. 636 unbundled rates
and enabled Interior to identify "nonallowable costs of mar-
keting," Final Rule, 62 Fed. Reg. at 65755/1, it was reason-
able for Interior to rigorously apply its conventional distinc-
tion between marketing and transportation.
Producers make two additional arguments regarding intra-
hub transfer fees. First, they seem to claim that Interior had
the ability to "look behind" the bundled rates prior to 1997.
But their citations to regulations governing deductions in the
non-arms-length bargaining context, see 30 C.F.R.
s 206.157(b)(2)(i) & (iii), offer little support. Indeed, they
seem only to further demonstrate Interior's historical reluc-
tance to separate actual transportation costs from "nonallowa-
ble costs of marketing" when such separation is administra-
tively difficult. Second, they argue that intra-hub transfer
fees are similar to other administrative costs, such as Gas
Supply Realignment, Annual Charge Adjustment, and Gas
Research Institute fees, which are deductible. Producers fail
to note, however, that these are mandatory surcharges im-
posed by FERC on gas transportation, and thus, unlike intra-
hub transfer fees, can be considered part of the actual cost of
transporting gas. See Final Rule, 62 Fed. Reg. at 65758.
"Unused" firm demand charges. Shippers of natural gas
may choose among different degrees of assurance that space
will be available for their shipments, paying (naturally) for
extra security. By paying a firm demand charge (an upfront
reservation fee), they secure a guaranteed amount of continu-
ously available pipeline capacity; when they actually ship,
they incur a "commodity charge" for the transport itself.
The reservation fee, however, is nonrefundable--the cost of
any reserved capacity that a lessee ultimately cannot use will
be lost unless it is able to resell the capacity. (Recall that the
district court amended the summary judgment order, at the
behest of the government, to provide for a credit to the
government in the event of such resales.) In contrast, with
"interruptible" service, shippers pay no reservation fee, but
their access to pipeline capacity is subject to the changing
needs of other, higher priority customers (i.e., those who pay
for firm demand). Producers claim that the unused firm
demand charges are part of their actual transportation costs,
and thus should be deductible.
In defense of its contrary view, Interior said only that it
does "not consider the amount paid for unused capacity as a
transportation cost," Final Rule, 62 Fed. Reg. at 65757/1, not
revealing to what category such expenses did belong. In its
opening brief, it quotes its prior assertion and declares that
the district court must be reversed because it "offered no
cogent reason for rejecting this distinction." Interior Br. at
43. But Interior has offered no "distinction" at all, only an
unusually raw ipse dixit. On its face, it is hard to see how
money paid for assurance of secure transportation is not "for
transportation"; the cost of freight insurance looks like a
shipping expense, for example, even if the goods arrive
without difficulty and the premium therefore goes "unused."
And Interior makes no suggestion that producers have in-
curred such fees extravagantly--an extravagance that seems
unlikely, as under the ordinary 1/8 lease the producer would
bear 7/8 of the loss. Further, under the crediting arrange-
ment provided by the district court order, the government
will share in any recovery of the "unused" charge, a recovery
that producers have strong incentives to pursue. While some
reason may lurk behind the government's position, it has
offered none, and we have no basis for sustaining its conclu-
sion. See, e.g., Motor Vehicle Manufacturers Ass'n, Inc. v.
State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).
* * *
The judgment of the district court is reversed on all issues
except for its ruling on unused firm demand charges, which
we affirm.
So ordered.
Sentelle, Circuit Judge, concurring: I join without reser-
vation the conclusion of the court, and the reasoning that is
essential to it. I find confusing, and indeed troubling, some
of the discussion of the applicability of Chevron deference to
the interpretation of statutes governing contracts in which
the agency has a financial interest. I of course agree with
the court's fundamental proposition that "the availability of
Chevron deference depends on congressional intent...."
Maj. op. at 7. Chevron itself makes plain that the deference
we afford an agency is created either by Congress "explicitly
[leaving] a gap for the agency to fill," or implicitly delegating
that authority to the agency by the decision of Congress not
to directly address "the precise question at issue" while
charging the agency with the administration and therefore
the interpretation of the "ambiguous" act. Chevron U.S.A.
Inc. v. Natural Resources Defense Council, 467 U.S. 837,
842-44 (1984). As the majority states, I "see no indication
here of a special intent to withhold deference" in the interpre-
tation of this act on a question as to which Congress has not
spoken directly. Maj. op. at 8. I find neither persuasive nor
necessary the court's reliance on interpretation of jurisdic-
tional limitations as in Oklahoma Natural Gas Co. v. FERC,
28 F.3d 1281, 1283-84 (D.C. Cir. 1994). That case involves
the very different question, to me a vexing one, of whether an
ambiguity as to the limitations of agency authority constitutes
the sort of implicit delegation upon which Chevron deference
rests. Further, I do not understand the majority's proposi-
tion that "a general withdrawal of deference on the basis of
agency self-interest might come close to overruling Chev-
ron...." Maj. op. at 7-8. We might as well propose that
judges can sit on cases in which they have a financial interest
because we regularly sit on cases on which we might exercise
self-aggrandizement by expansively interpreting our jurisdic-
tion. Nonetheless, because this discussion is no more than
dicta, and not at all essential to the court's conclusion, I
concur in the decision reached and in the balance of the
opinion.