OXY USA v. DOI

Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 1
FILED
United States Court of Appeals
PUBLISH Tenth Circuit

UNITED STATES COURT OF APPEALS May 2, 2022
Christopher M. Wolpert
FOR THE TENTH CIRCUIT Clerk of Court
_________________________________

OXY USA INC.,

Plaintiff - Appellant,

v. No. 21-2011

UNITED STATES DEPARTMENT OF
THE INTERIOR; OFFICE OF NATURAL
RESOURCES REVENUE; GREGORY
GOULD, in his official capacity as
Director of the Office of Natural Resources
Revenue,

Defendants - Appellees.
_________________________________

Appeal from the United States District Court
for the District of New Mexico
(D.C. No. 1:19-CV-00151-KWR-JHR)
_________________________________

James M. Auslander (Peter J. Schaumberg, with him on the briefs), Beveridge &
Diamond, P.C., Washington, DC, appearing for Appellant.

Andrew M. Bernie, Attorney (Todd Kim, Assistant Attorney General, and John Smeltzer,
Attorney, with him on the brief), United States Department of Justice, Environment and
Natural Resources Division, Washington, DC, appearing for Appellees.
_________________________________

Before HOLMES, BRISCOE, and MORITZ, Circuit Judges.
_________________________________

BRISCOE, Circuit Judge.
_________________________________
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 2

This case concerns the valuation of royalties to be paid on carbon dioxide

(“CO2”) produced from federal oil and gas leases now owned by OXY USA, Inc.

(“OXY”). OXY appeals the decision of the U.S. Department of the Interior’s Office

of Natural Resources Revenue (“ONRR”) ordering it to pay an additional

$1,820,652.66 in royalty payments on federal gas leases that are committed to the

Bravo Dome Unit (“the Unit”). Under the Mineral Leasing Act, federal lessees must

pay royalties of at least 12.5 percent on the value of the CO2 removed or sold from

their lease properties. When lessees sell their gas in arm’s-length transactions, 1 the

sales price can generally be used to determine value for royalty purposes. But during

the relevant audit period, the owner of the leases OXY subsequently acquired—

Amerada Hess Corporation (“Hess”)—used almost all of the CO2 it produced in the

Unit for its own purposes rather than sale. 2

Following an audit, ONRR rejected Hess’s valuation method and established

its own. Hess appealed, and ONRR’s Director issued a decision reducing the amount

Hess owed but affirming the remainder of ONRR’s order. Hess appealed to the

1
Arm’s-length transactions involve contracts or agreements that have been
arrived at in the marketplace between independent, nonaffiliated persons with
opposing economic interests regarding those contracts. 30 C.F.R. § 206.151.
2
During the relevant audit period, Hess was the lessee of the federal leases at
issue in this appeal. OXY obtained the leases from Hess in 2017, after ONRR’s
order was issued. Unless otherwise indicated herein, we refer to Hess for time
periods before 2017 and to OXY for later periods. Beyond the leases OXY acquired
from Hess, OXY holds other federal Unit leases, but they are not at issue in this case
because the agency’s decision does not cover them.

2
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 3

Interior Board of Land Appeals, but the Board did not issue a final merits decision

prior to the 33-month limitations period. On appeal to the United States District

Court for the District of New Mexico, the district court rejected OXY’s challenge to

the amount of royalties owed and affirmed the Director’s decision.

Exercising jurisdiction under 28 U.S.C. § 1291, we affirm.

I

A. Statutory and Regulatory Background

1. Mineral Leasing Act of 1920 and Federal Oil and Gas Royalty
Management Act of 1982

The Mineral Leasing Act of 1920 regulates the leasing of public lands for

developing deposits of federally owned coal, petroleum, natural gas, and other

minerals. 30 U.S.C. § 181 et seq. Lessees must pay a royalty “at a rate of not less

than 12.5 percent in amount or value of the production removed or sold from the

lease.” 30 U.S.C. § 226(b)(1)(A).

In 1982, Congress passed the Federal Oil and Gas Royalty Management Act in

order “to ensure the prompt and proper collection and disbursement of oil and gas

revenues.” H.R. Rep. No. 97-859, at *1 (1982). The Act directs the Secretary of the

Interior to “establish a comprehensive inspection, collection and fiscal and

production accounting and auditing system” to determine and collect oil and gas

royalties. 30 U.S.C. § 1711(a). The Secretary of the Interior also is required to

“audit and reconcile, to the extent practicable, all current and past lease accounts for

3
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 4

leases of oil or gas and take appropriate actions to make additional collections or

refunds as warranted.” § 1711(c)(1).

2. ONRR’s 1988 Valuation Regulations

The regulations in effect during the relevant period were issued by the Interior

Department’s Minerals Management Service in 1988 and codified at 30 C.F.R.

§ 206. 3 See 53 Fed. Reg. 1230 (Jan. 15, 1988). The regulations provide that with

narrow exceptions, if a lessee disposed of its production pursuant to an arm’s-length

contract, the gross proceeds accruing to the lessee under that contract determine the

value of the gas for royalty purposes. 30 C.F.R. §§ 206.152(b)(1)(i)–(iv). For gas

production not disposed of pursuant to an arm’s-length contract, the lessee must

value its gas pursuant to the “first applicable” of three possible benchmarks:

(1) The gross proceeds accruing to the lessee pursuant to a sale under its
non-arm’s-length contract (or other disposition other than by an
arm’s-length contract), provided that those gross proceeds are
equivalent to the gross proceeds derived from, or paid under,
comparable arm’s-length contracts for purchase, sales, or other
dispositions of like-quality gas in the same field (or, if necessary to
obtain a reasonable sample, from the same area). In evaluating the
comparability of arm’s-length contracts for the purposes of these
regulations, the following factors shall be considered: price, time of
execution, duration, market or markets served, terms, quality of gas,
volume, and such other factors as may be appropriate to reflect the
value of the gas.

3
In 2010, ONRR replaced the Minerals Management Service, and the
regulations at 30 C.F.R. § 206 were redesignated as 30 C.F.R. § 1206 without
material change. See 75 Fed. Reg. 61,051 (Oct. 4, 2010). The regulations have since
been amended further and are the subject of both litigation and additional proposed
rulemaking, but none of these subsequent developments are relevant to this case. For
consistency, we cite to the 1988 regulations using the 30 C.F.R. § 206 citations.
4
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 5

(2) A value determined by consideration of other information relevant in
valuing like-quality gas, including gross proceeds under arm’s-length
contracts for like-quality gas in the same field or nearby fields or areas,
posted prices for gas, prices received in arm’s-length spot of sales of
gas, other reliable public sources of price or market information, and
other information as to the particular lease operation or the saleability of
the gas; or

(3) A net-back method or any other reasonable method to determine
value.

§§ 206.152(c)(1)–(3). Put another way, if gas is not sold pursuant to an arm’s-length

contract but is sold pursuant to an equivalent non-arm’s-length contract, the lessee

must value its gas pursuant to the first regulatory benchmark. 4 If gas is not sold

pursuant to an arm’s-length contract or an equivalent non-arm’s-length contract (as

in OXY’s case), a lessee must turn to the second regulatory benchmark, which is

more open-ended. § 206.152(c)(2).

After a lessee calculates the value of gas, ONRR allows the lessee to take a

transportation allowance, or “a deduction for the reasonable actual costs incurred by

the lessee to transport unprocessed gas, residue gas, and gas plant products from a

lease to a point off the lease.” § 206.156(a). The regulations clarify that “[t]he

lessee must place gas in marketable condition . . . at no cost to the Federal

Government,” which means that the lessee cannot include the costs required to place

the gas in marketable condition in the transportation allowance. § 206.152(i)

4
The parties do not dispute ONRR’s conclusion that the first regulatory
benchmark does not apply because Hess took the majority of its CO2 production from
the Unit in-kind and did not accrue gross proceeds under a non-arm’s-length contract.

5
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 6

(emphasis added). All transportation allowances deducted under a non-arm’s-length

or no contract situation are subject to ONRR’s monitoring, review, audit, and

adjustment, and the agency “may direct a lessee to modify its estimated or actual

transportation allowance deduction.” § 206.157(b).

In determining a non-arm’s-length transportation allowance, a lessee also may

include certain “allowable costs.” § 206.157(f). The regulations directly address the

two costs at issue in OXY’s case: compression and dehydration. 5 The regulations

allow a lessee to include “[s]upplemental costs for compression, dehydration, and

treatment of gas . . . only if such services [1] are required for transportation and

[2] exceed the services necessary to place production into marketable condition.”

§ 206.157(f)(9) (emphasis added).

All royalty payments then are subject to ONRR’s audit and adjustment, and

ONRR “will direct a lessee to use a different value if it determines that the reported

value is inconsistent with the requirements of these regulations.” §§ 206.150(c),

206.152(e)(1).

An important feature of the regulations at issue in this case is that “[i]f the

specific provisions of any [Federal oil or gas lease] . . . are inconsistent with any

regulation [applicable to the gas production from Federal oil and gas leases], then the

lease . . . shall govern to the extent of that inconsistency.” § 206.150(b). The

5
Compression and dehydration are processes that remove unacceptable liquids
and impurities from natural gas extracted from the ground and prepare the gas for
safe transport and use.

6
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 7

regulations explain that their purpose “is to establish the value of production for

royalty purposes consistent with . . . lease terms” and they “are intended to ensure

that the administration of oil and gas leases is discharged in accordance with the

requirements of the governing mineral leasing laws and lease terms.” §§ 206.150(a),

(d). In short, the relevant regulations are meant to be applied as follows: If the

regulation is inconsistent with a lease, then the lease governs to the extent of that

inconsistency.

B. Factual and Procedural Background

1. The Bravo Dome Unit and Unit Agreement

Hess produced CO2 from numerous federal leases (“Leases”) in Harding,

Quay, and Union Counties in northern New Mexico. 6 Under the Leases’ terms, Hess

agreed to pay the United States, as lessor, “12 ½ percent royalty on the production

removed or sold from the leased lands computed in accordance with the Oil and Gas

Operating Regulations (30 C.F.R. Pt. 221).” ROA, at 442b, 446b, 450b, 454b

[Sec. 2(d)(l)]. The Leases further state:

It is expressly agreed that the Secretary of the Interior may establish
reasonable minimum values for purposes of computing royalty on any
or all oil, gas, natural gasoline, and other products obtained from gas,
due consideration being given [1] to the highest price paid for a part or
for a majority of production of like quality in the same field, [2] to the
price received by the lessee, [3] to posted prices, and [4] to other
relevant matters and, whenever appropriate, after notice and opportunity
to be heard.

6
The record contains a total of four Leases, and their relevant terms are
identical. See ROA, at 442, 446, 450, 454.

7
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 8

Id. [Sec. 2(d)(2)] (“Lease valuation factors”). The Leases clarified that Hess was

“subject to any unit agreement heretofore or hereafter approved by the Secretary of

the Interior, the provisions of said agreement to govern the lands subject thereto

where inconsistent with the terms of this lease.” Id. at 442a, 446a, 450a, 454a

[Sec. 1].

Bravo Dome is a natural carbon source field located in northeastern New

Mexico. In 1979, the Bravo Dome Unit was formed under the Bravo Dome Carbon

Dioxide Unit Agreement (“Unit Agreement”) to consolidate and coordinate CO2

production from a number of both federal and non-federal leases in the Bravo Dome

area, including Hess’s Leases. Id. at 415–40. Under the terms of the Unit

Agreement, once the Unit Operator allocated CO2 to each tract in the Unit, each

working-interest owner 7 remitted payment to its royalty-interest owners. Id. at 429

[§ 6.3]. The original Unit Operator was Amoco Production Company (“Amoco”),

but Amoco’s successor-in-interest OXY was the Unit Operator during the relevant

audit period.

The Unit Agreement modified the underlying Leases to the extent of any

inconsistencies, and it incorporated the federal oil and gas operating regulations

“provided such regulations are not inconsistent with the terms of this Agreement.”

Id. at 417, 424 [§ 3.3], 438 [§ 15.1]. The Unit Agreement also attempted to modify

A working-interest owner is someone who owns the right to search, develop,
7

and produce oil and gas on the leased property as well as pay all costs. ROA, at 219.

8
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 9

the royalty clauses in the Leases committed to the Unit in two ways. First, royalty

was due on CO2 at “the standard conditions of measurement for natural gases which

are at 60° Fahrenheit and 15.025 pounds per square inch absolute [‘psia’] pressure

base.” Id. at 429 [§ 6.2]. Second, the Unit Agreement attempted to amend the

royalty clauses to base royalty payments on the higher of “(a) the net proceeds

derived from the sale of Carbon Dioxide Gas at the well whether such sale is to one

or more of the parties to this agreement or to any other party or parties; or (b) a

minimum value at the well of twelve cents per thousand cubic feet ($0.12/mcf).” Id.

[§ 6.3].

For the Unit Agreement to be effective, Amoco was required to submit it to the

United States Geological Survey (“USGS”) for approval. 8 On August 29, 1980,

USGS approved the Unit Agreement, with a few exceptions. Id. at 465. In the

Determination approving the Unit Agreement, USGS certified that the Unit

Agreement modified the Leases’ terms to the extent of any inconsistencies. Id. But

USGS excluded some provisions of the Unit Agreement from its approval, the

relevant exclusion being § 6.3(b)—the twelve cents per thousand cubic feet minimum

value. Id. The Determination stated that “the provisions of Article 6.3(b) shall not

apply to the Federal lands and the United States reserves the right to establish higher

8
In 1980, when the Unit was formed, the applicable regulations required a
supervisor of the USGS to approve unit agreements. The supervisor was required to
make a determination that the unit was necessary or advisable in the public interest
and was for the purpose of conserving the natural resource. See 30 U.S.C. § 226.8
(1980); ROA, at 220.

9
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 10

minimum values for Federal substances.” Id. Therefore, the approved Unit

Agreement required federal lessees to pay royalties on the higher of either (1) the net

proceeds derived from the sale of CO2 gas at the well, or (2) a minimum value

established by the United States. Id. at 429 [§ 6.3], 465.

2. Hess Operations and Royalty Payments

Hess owned approximately ten percent of the working interest in the Unit since

it was formed. During the relevant audit period, Hess sold a small percentage of the

CO2 it produced from the Unit under an arm’s-length contract with Fasken Oil and

Ranch, Ltd. (“Fasken Contract”). Id. at 222. Hess had no other sales of CO2 during

the relevant period. Id. at 224. Hess instead used the vast majority of the CO2

allocated to its Leases for its own use in enhanced oil recovery (“EOR”) projects in

the Permian Basin in West Texas and New Mexico. 9 Id. at 223–24. In addition to

sourcing its own CO2 from the Unit, Hess also purchased a large volume of CO2 from

other Unit working-interest owners to use in its EOR operations (“Hess Purchase

Contracts”). Id.

To transport the CO2 from the Unit to the Permian Basin EOR units, Hess first

transported the CO2 through the Rosebud Pipeline and Sheep Mountain Pipeline to a

9
Enhanced oil recovery is the extraction of crude oil from an oil field that
cannot be extracted otherwise. The process involves injecting liquified CO2 into the
pore space of reservoir rock to help displace oil and drive it to a production wellbore.
At the surface, the CO2 is separated from the oil, the oil is sold, and the CO2 is reused
again in the EOR reservoir. This means that the CO2 used in EOR operations is part
of a continual process and is not sold. See, e.g., ROA, at 223–24.

10
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 11

hub in Denver City, Texas (“Denver Hub”). Id. at 221. From the Denver Hub, Hess

transferred the CO2 into two other pipelines for delivery into the Permian Basin EOR

units. Id. Each step of transportation required the CO2 to be at a particular pressure.

The wellhead pressure of the CO2 in the Unit ranged from 16 to 78 pounds per square

inch gauge (“psig”), but the pressure necessary to enter the Rosebud Pipeline was

1,850 psig. Id. Accordingly, before the CO2 could enter the Rosebud Pipeline, Hess

gathered the CO2 on the Unit and compressed it to 1,850 psig. Along the route to the

Permian Basin EOR units, the pressure of the CO2 again was appropriately adjusted

to meet the varying pressure requirements: 1,925 psig at the interconnect between the

Rosebud Pipeline and Sheep Mountain Pipeline; 2,150 psig at the outlet of the Sheep

Mountain Pipeline at the Denver Hub; and upwards of 2,500 psig to enter the

Permian Basin EOR units. Id. at 221–22.

To comply with the applicable laws, Hess was required to value its CO2

production for royalty purposes. Because Hess transported the majority of its federal

CO2 production to the Permian Basin EOR units (only a small percentage went to the

Fasken Contract) and the CO2 continued to be reused in the Permian Basin EOR

units, Hess had no other sales of CO2 to use as reference for royalty valuation. Id.

at 224. During the audit period, Hess paid royalties based on “the Unit Average,”

which the Unit Operator provided lessees on a monthly basis using a “netback

approach.” Id. Under the netback approach, the Unit Operator determined the Unit

Average by taking the price or value lessees in the Unit received for their sale of the

CO2 at the Denver Hub. Id. The Unit Operator then deducted transportation costs

11
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 12

from those values and prices to arrive at a value for the CO2 removed at the Unit. Id.

Hess reported these prices as the basis of its royalty payments throughout the audit

period. Id.

Beginning in March 2004, Hess also started reporting the compression and

dehydration costs it incurred for delivery to the Permian Basin EOR units as a

transportation allowance. Id. Hess reported compression and dehydration costs in

the amount of $806,290.73 during the audit period. Id. at 276.

3. Smithson Litigation and Arbitration Decision

During the audit period, Hess also was a working-interest owner and operator

in some of the EOR units in West Texas. Id. at 222. In 2006, a group of private

lease royalty owners sued Hess in the District of New Mexico, alleging that Hess

undervalued royalties by intentionally negotiating lower prices for the CO2 in its

purchase contracts and then using that lower price to value its in-kind sales to

determine the amount of royalties it owed. See Smithson v. Amerada Hess Corp.,

No. 06-624-MCA (D.N.M. 2006).

The matter proceeded to arbitration. A three-member arbitration panel

determined that from October 2003 through December 2008, Hess had breached its

duty of good faith and fair dealing to the royalty owners by obtaining the lowest

fixed price possible for CO2 and using this “improper benchmark” to value its in-kind

sales to them. ROA, at 351. To calculate a proper price, the panel “considered the

numerous options of benchmarks and methodologies offered by the parties at the

arbitration,” as well as the trove of evidence the parties provided that included

12
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 13

contracts and relevant pricing mechanisms. Id. at 353, 356–66. The panel also

considered the testimony of Hess’s valuation specialist, who indicated that the proper

formula “should be reflective of the market conditions in the fall of 2003, as well as

reflecting the historical contracting practices from the . . . pool of contracts [that the

parties provided].” Id. at 274. The panel ultimately determined that “the ‘blend’ of

the 2 methods suggested by [Hess’s valuation specialist] . . . [was] the proper

benchmark for the applicable period” (“the Smithson formula”). Id.; see also id.

at 356–66 (detailing the Smithson formula).

Hess sought vacatur of the arbitration panel’s decision, but the parties then

entered a settlement agreement. Id. at 263–69. In March 2010, the district court

approved the settlement agreement. Id. at 489–94.

4. New Mexico Audit

Pursuant to 30 U.S.C. § 1735, ONRR delegated authority to audit Hess’s

royalty reports and payments for the period of January 1, 2002, to November 30,

2010, to New Mexico’s Taxation and Revenue Department (“New Mexico”).

On September 22, 2009, New Mexico sent Hess an initial audit issue letter

stating that Hess owed an additional $1,458,127.94 for the period of January 2002

through December 2005. Id. at 292–97. The letter suggested that the third regulatory

benchmark applied (the net-back method, 30 C.F.R. § 206.152(c)(3)) and valued

Hess’s CO2 based on the single arm’s-length Fasken Contract. Id. at 295.

New Mexico then corresponded with ONRR regarding Hess’s CO2 valuation

and allowable transportation deductions. On January 12, 2011, ONRR sent New

13
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 14

Mexico a response letter. Id. at 407–11. In the response letter, ONRR explained that

although the Minerals Management Service had in the past directed the Unit’s

producers to value their gas based on the Unit Average, “under different market

scenarios and dispositions of Bravo Dome production, it does not dictate how value

for royalty purposes must be established during later time periods.” Id. at 410. In

doing so, ONRR noted that the Unit Average “falls short” because CO2 values

determined by other Unit producers, including non-federal lessees, would not

necessarily be relevant and ONRR could not easily verify whether such valuations

met federal requirements. Id.

ONRR went on to explain that “absent lack of significant arm’s-length sales in

the Bravo Dome field, royalty value must be determined in the Permian Basin EOR

units where there is an established market for CO2”—i.e., where Hess ultimately used

the CO2. Id. But ONRR observed that Hess purchased large quantities of CO2 for its

own use and on behalf of other working-interest owners in its Permian Basin EOR

operations. Id. Hess therefore had “far more incentive to obtain the lowest possible

price for CO2 used in its Permian Basin EOR Units than it [did] to obtain a reasonable

value for the government’s royalty share of CO2 from the Bravo Dome Unit” and was

arguably “able to depress the market price of CO2 in order to obtain the highest

possible return on its Permian Basin oil production.” Id. Consequently, ONRR

concluded that the Smithson formula was a reasonable valuation under the second

regulatory benchmark. Id. (citing 30 C.F.R. § 206.152(c)(2)).

14
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 15

Regarding whether Hess’s compression and dehydration costs could be

deducted as a transportation allowance, ONRR determined that “since the Permian

Basin [where Hess used the CO2 in EOR units] is the market for Bravo Dome CO2,

the requirements to place CO2 into marketable condition would be established there.”

Id. at 411. This meant that “[a]ny costs incurred to compress the CO2 up to [the

required pressure for injection at the Permian Basin EOR units] would not be

deductible from royalties as a transportation allowance.” Id.

On February 1, 2011, New Mexico sent Hess a revised issue letter that was

generally consistent with ONRR’s January 12, 2011 letter. Id. at 285–91. The

revised letter acknowledged that although the Unit Average valuation method “may

have been acceptable in the past under different market scenarios and dispositions of

Bravo Dome production, it does not dictate how value for royalty purposes must be

established during the later periods.” Id. at 286. In Hess’s case, the lack of

arm’s-length sales of significant volumes in the Bravo Dome field meant that

“royalty value must be determined in the Permian Basin EOR units where there is an

established market for CO2.” Id. at 286–87. The revised letter further explained that

because Hess did not dispose of the majority of its CO2 under arm’s-length contracts,

Hess should value its production using the Smithson formula under the second

regulatory benchmark. Id. Regarding transportation deductions, the revised letter

stated that “[c]ompression and dehydration costs are costs to get the CO2 gas to

marketable condition needed for EOR production,” so Hess could not deduct the

costs incurred to compress the CO2 up to the pressure requirement for the EOR

15
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 16

delivery pipelines as a transportation allowance. Id. at 288. The revised letter also

expanded the audit period to run from January 1, 2002, through November 30, 2010.

Id. at 285.

On March 11, 2011, Hess responded to the revised issue letter and raised

arguments regarding valuation and marketable condition. Id. at 276–79. After

reviewing Hess’s response, New Mexico reevaluated its proposed valuation method

but adhered to its position that the Unit Average was an inappropriate valuation

method and that Hess’s claimed compression and dehydration costs were not

deductible as a transportation allowance. Id. at 225–26.

5. Administrative Proceedings

On December 19, 2011, ONRR issued an Order to Report and Pay Additional

Royalties based on New Mexico’s audit that ordered Hess to report and pay

additional royalties of $1,874,524.54 for the audit period of January 1, 2002, through

November 30, 2010. Id. at 270–82. Additionally, in its royalty reports, Hess had

reported CO2 volumes based on a pressure base of 15.025 psia in accordance with the

terms of the Unit Agreement. Id. at 429 [§ 6.2]. The Order required Hess to correct

its royalty reports to report CO2 volumes based on a pressure base of 14.73 psia in

accordance with the 1988 regulations. See 30 C.F.R. § 202.152.

In the Order, ONRR explained that Hess’s use of the Unit Average price to

value its CO2 production was unacceptable because no mechanism was in place to

verify (1) if the Unit sales price reported by all producers to the Unit Operator was in

accordance with federal regulations; (2) how the price was derived from producers;

16
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 17

(3) if producers reduced their reported Unit prices, as provided to the Unit Operator,

by the cost of placing the CO2 production into marketable condition; (4) if calculated

transportation costs were in accordance with federal regulations; or (5) if all federal

lessees were using the Unit Average price when paying royalties. Id. at 272. Put

simply, ONRR rejected Hess’s supplied Unit Average valuation because it included

unverified arm’s-length and non-arm’s-length sales.

ONRR then outlined how Hess was required to value its CO2 production for

royalty purposes. The majority of the CO2 that Hess produced (more than 99%) was

transported for use in the Permian Basin EOR units, and while Hess sold a de

minimus volume of CO2 under the single arm’s-length Fasken Contract, “the gross

proceeds were not equivalent to the gross proceeds derived from, or paid under,

comparable arm’s-length contracts.” Id. at 271. Taking this into consideration along

with the variability of pricing mechanisms present in the Hess Purchase Contracts,

ONRR directed the use of the following valuations for the audit period:

• January 2002–September 2003 & April 2008–November 2010: The
best representation of value for these periods was a “weighted average,”
which included only Hess’s verified purchases of CO2 in the Permian
Basin as well as the Fasken Contract.

• October 2003–March 2008: The best representation of value for this
period was the Smithson formula because this formula was based on
transparent, reliable, and relevant evidence including expert testimony

17
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 18

from Hess’s valuation specialist and CO2 purchase contracts, pricing
mechanisms, and historical contracting practices from this time. 10

Id. at 273–74.

ONRR further agreed with New Mexico’s conclusion that Hess could not

deduct its compression and dehydration costs as a transportation allowance. Id.

at 275–76. ONRR observed that the pressure required for CO2 delivery along the

pipelines to the Permian Basin did not exceed the pressure requirements for use in the

Permian Basin EOR units, plus typical sales or purchases contracts for the Unit’s

CO2 production also contained these pressure requirements as a condition for use in

the Permian Basin EOR units. Id. at 275. The costs of compression and dehydration

up to the EOR requirements, ONRR reasoned, therefore were costs of placing the

CO2 into marketable condition. Id. ONRR noted that substantial case law supported

its position to disallow the costs of compression and dehydration necessary to meet

pressure requirements for CO2 delivery to EOR operations. Id. at 276 (citing Devon

Energy Corp. v. Kempthorne, 551 F.3d 1030, 1036–40 (D.C. Cir. 2008), and Amoco

Prod. Co. v. Watson, 410 F.3d 722, 729–31 (D.C. Cir. 2005), aff’d sub nom., BP Am.

Prod. Co. v. Burton, 549 U.S. 84 (2006)). Hess appealed the Order to ONRR’s

Director. Id. at 218.

10
OXY asserts that ONRR “ordered Hess to use three different values for the
same CO2 during the Audit Period,” but the record shows that the agency directed the
use of only two values: the “weighted average” and the Smithson formula. Compare
Aplt. Br. at 12 with ROA, 273–74.

18
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 19

On September 13, 2016, ONRR’s Director issued a decision, which largely

affirmed the agency’s Order to Report and Pay Additional Royalties. Id. at 217–54.

The Director determined that ONRR reasonably established a minimum value for

Hess to use to calculate the value of its federal CO2 production based on Hess’s gross

proceeds under the Fasken Contract, the price that Hess purchased CO2 from other

lessees, and the Smithson formula. In reaching this conclusion, the Director found

that ONRR never had required Hess to only use the Unit Average valuation and that

the terms of the Unit Agreement and underlying Leases actually allowed ONRR,

independent of the 1988 regulations, to establish a reasonable value for Hess’s CO2

within the bounds of the Lease valuation factors. Id. at 227–28, 248–53. But the

Director also analyzed ONRR’s valuation under the applicable 1988 regulations,

specifically the second regulatory benchmark, and determined that the result would

be the same. Id. at 239–43. The Director then determined that ONRR properly

denied Hess’s claimed compression and dehydration costs as a transportation

allowance because these costs were necessary to place the CO2 in marketable

condition. Id. at 243–47.

Lastly, regarding the pressure base calculation, the Director realized that the

regulations and Unit Agreement were in conflict on this point. Id. at 247–48. In

1980, when USGS approved the Unit Agreement, the regulations required lessees to

base royalty payments on “10 ounces above an atmospheric pressure of 14.4 pounds

to the square inch, regardless of the atmospheric pressure at the point of

measurement.” Id. (citing 30 C.F.R. § 221.44 (1980)). The regulations required

19
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 20

lessees to adjust their royalty computation to those standards “unless otherwise

authorized in writing by the supervisor.” Id. Because USGS approved the Unit

Agreement in writing and the Unit Agreement required Hess to remit royalties on

CO2 volumes at a pressure base on 15.025 psia, the Director determined that Hess

needed to report and pay royalties on volumes at the 15.025 psia pressure base. Id.

The Director applied the correct pressure base and reduced the royalty amount due

accordingly. 11 Id.

Hess appealed to the Interior Board of Land Appeals, which exercises the

Secretary of the Interior’s de novo review authority for subordinate agency decisions.

Id. at 330. The Board did not issue a final merits decision prior to the 33-month

limitations period. See 30 U.S.C. § 1724(h)(1); ROA, at 321–23. The Director’s

decision thus became the agency’s final decision ripe for judicial review. 30 U.S.C.

§ 1724(h)(2)(B); 43 C.F.R. § 4.906(a).

6. District Court Opinion

OXY then brought this lawsuit, challenging the decision of ONRR’s Director

under the Administrative Procedure Act (“APA”), 5 U.S.C. § 706(2)(A). ROA,

at 19–22. Applying the appropriate deferential standard of review, the district court

affirmed the Director’s decision. Id. at 70–93. The district court first acknowledged

11
The Director reduced the amount due from $1,874,524.54 to $1,820,652.66
(a difference of $53,891.88), which reflects the amount due as a result of previously
requiring Hess to report its CO2 volumes on a 14.73 psia pressure base. ROA,
at 247–48, 253. OXY does not challenge the Director’s calculation of the pressure
base or that the Unit Agreement is controlling in this aspect.

20
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 21

the Director’s conclusion that ONRR’s valuation was to be assessed under the Lease

valuation factors, and it observed that ONRR had considered the relevant factors and

evidence in establishing a reasonable minimum value and had thoroughly explained

its decision. Id. at 78–84. ONRR also had “appropriately considered and rejected

the Unit Average,” as the Director’s decision “extensively explained why the Unit

Average was not satisfactory and why [the agency] was using a new valuation

method.” Id. at 84–85.

The district court then considered the Director’s alternative conclusion that

ONRR’s valuation also was reasonable under the second regulatory benchmark. Id.

at 87. Because the Director had analyzed the relevant facts and articulated what

evidence he considered under each regulatory valuation factor, the district court

determined that it “[would] not second-guess the Director’s decision in weighing the

regulatory factors.” Id.

Finally, regarding whether compression and dehydration costs were deductible

as a transportation allowance, the district court concluded that the Director’s decision

“cogently explain[ed] that the costs are not deductible because they are necessary to

place the carbon dioxide in marketable condition.” Id. at 88. In particular, the

Director’s interpretation and application of the marketable-condition rule to OXY’s

case was “not plainly erroneous or inconsistent with the regulation.” Id. at 91.

OXY now appeals to this court.

21
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 22

II

We review the district court’s decision in APA cases de novo. N.M. Cattle

Growers Ass’n v. Fish & Wildlife Serv., 248 F.3d 1277, 1281 (10th Cir. 2001).

Under the APA, we may set aside agency action only if it is “arbitrary, capricious, an

abuse of discretion, or otherwise not in accordance with law.” 5 U.S.C. § 706(2)(A).

An agency’s decision is arbitrary and capricious if the agency (1) “entirely failed to

consider an important aspect of the problem,” (2) “offered an explanation for its

decision that runs counter to the evidence before the agency, or is so implausible that

it could not be ascribed to a difference in view or the product of agency expertise,”

(3) “failed to base its decision on consideration of the relevant factors,” or (4) made

“a clear error of judgment.” Utah Env’t Cong. v. Troyer, 479 F.3d 1269, 1280 (10th

Cir. 2007) (internal citations and quotations omitted). Our “inquiry under the APA

must be thorough, but the standard of review is very deferential to the agency.”

Hillsdale Env’t Loss Prevention, Inc. v. U.S. Army Corps of Eng’rs, 702 F.3d 1156,

1165 (10th Cir. 2012).

Under this standard, we ask whether the agency’s interpretation of the

regulations at issue was based on an examination of the relevant evidence and if the

agency “articulated a rational connection between the facts found and the decision

made.” Payton v. U.S. Dep’t of Agric., 337 F.3d 1163, 1168 (10th Cir. 2003). We

may reject the agency’s interpretation only when the interpretation is unreasonable,

plainly erroneous, or inconsistent with the regulation’s plain meaning. Biodiversity

22
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 23

Conservation All. v. Jiron, 762 F.3d 1036, 1060 (10th Cir. 2014) (citing Utah Env’t

Cong., 479 F.3d at 1281).

We also “will set aside the [agency’s] factual determinations only if they are

unsupported by substantial evidence.” Forest Guardians v. U.S. Fish & Wildlife

Serv., 611 F.3d 692, 704 (10th Cir. 2010) (alteration in original). Substantial

evidence is such relevant evidence as a reasonable mind might accept as adequate to

support a conclusion. Pennaco Energy, Inc. v. U.S. Dep’t of the Interior, 377 F.3d

1147, 1156 (10th Cir. 2004) (internal citation omitted). The substantial evidence

standard does not allow us to displace the agency’s choice “between two fairly

conflicting views, even though [we] would justifiably have made a different choice

had the matter been before [us] de novo.” Wyo. Farm Bureau Fed’n v. Babbitt,

199 F.3d 1224, 1231 (10th Cir. 2000) (internal quotations omitted).

III

OXY argues on appeal that ONRR’s decision is arbitrary, unsubstantiated, and

internally inconsistent and the district court erred in affirming the agency’s decision.

OXY asserts that ONRR’s Director incorrectly found the agency’s valuation

reasonable under the Lease valuation factors, improperly rejected Hess’s Unit

Average as the valuation method, and misapplied the 1988 regulatory factors to

alternatively affirm the agency’s valuation under the second regulatory benchmark.

OXY further asserts that the Director erred in determining that Hess’s compression

and dehydration costs are not deductible as a transportation allowance.

23
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 24

We conclude that ONRR’s valuation is not arbitrary or capricious, is supported

by substantial evidence, and is otherwise in accordance with law, and we affirm the

Director’s decision. We will address each of OXY’s contentions in turn.

A. ONRR’s Valuation

We first will consider whether the Director erred in determining that ONRR

reasonably established a minimum value for Hess to use to calculate the value of its

federal CO2 production. ONRR’s valuation used (1) the “weighted average” from

January 2002 to September 2003 and April 2008 to November 2010, and (2) the

Smithson formula from October 2003 to March 2008. ROA, at 273–74.

At the outset of the Director’s decision, the Director noted that the approved

Unit Agreement, along with the underlying Leases, required the federal lessees to pay

royalties on the higher of either (1) the net proceeds derived from the sale of CO2 gas

at the well, or (2) a minimum value established by the United States. Id. at 429

[§ 6.3], 465. Recall that if the applicable 1988 regulation is inconsistent with a lease,

then the lease governs to the extent of that inconsistency. 30 C.F.R. § 206.150(b).

The 1988 regulations authorize a lessee to first compute the minimum royalty value

through the benchmark system, and ONRR is then empowered to determine whether

the lessee’s valuation is inconsistent with the applicable regulations.

§§ 206.152(c)(1)–(3), 206.152(e)(1). In contrast, under the Unit Agreement and

underlying Leases, the Secretary retains the right to establish the royalty value on

CO2 production based on the Lease valuation factors following notice and an

opportunity to be heard when appropriate. After comparing the regulations and the

24
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 25

Unit Agreement, the Director determined that “[t]he Leases and Unit Agreement

govern the value of Hess’s CO2 for federal royalty purposes” because “the Secretary

retained the right to establish a minimum value for federal CO2 production in the

Unit in its approval of the Unit Agreement.” ROA, at 227–28, 239.

Because Hess did not sell the CO2 production at issue, the Director evaluated

ONRR’s valuation under the Lease valuation factors to see if ONRR had properly

established a reasonable minimum value, after giving Hess notice and an opportunity

to be heard:

(1) The Highest Price Paid for a Part or for a Majority of Production of
Like Quality in the Same Field: The Director explained that federal
lessees in the Unit (holding less than ten percent of an interest in the
Unit) sell less than one percent of the CO2 produced from the federal
lands. Federal lessees use the remainder in their EOR operations.
ONRR only had data for the federal CO2 production and considered that
data set, but the agency reasonably concluded that the data set was too
small to accurately establish a minimum value. ONRR also could not
consider the Hess Purchase Contracts under the first factor because the
agency could not determine whether such contracts represented the
“highest price paid” for a part or majority of production from the Unit.
The Director concluded that ONRR had properly considered this factor.

(2) The Price Hess Received for the CO2: ONRR considered the Fasken
Contract in the context of the “weighted average” calculation, but
because this represented a very small fraction of Hess’s federal CO2
disposition, ONRR determined that it could not solely rely on these
prices alone. The Director concluded that ONRR had properly
considered this factor.

(3) Posted Prices: ONRR could not consider posted prices for CO2
production because no posted prices for CO2 in the Unit existed during
the audit period. The Director concluded that ONRR had properly
considered this factor.

(4) Other Relevant Matters: ONRR considered the Unit Average, the
prices at which Hess purchased CO2 under the Hess Purchase Contracts,

25
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 26

and pricing mechanisms used in Hess’s settlements and arbitrations,
including the Smithson formula. The Director found that these
considerations were reasonable, as they helped ONRR identify reliable
indicators of value. The Director concluded that ONRR had properly
considered this factor.

Id. at 227–39; see also id. at 442b, 446b, 450b, 454b [Sec. 2(d)(2)]. The Director

concluded overall that there was insufficient information as to the first and third

factors, so ONRR’s reliance on the second and fourth factors to establish its valuation

was reasonable.

In determining that ONRR’s valuation was reasonable, the Director explained

why ONRR’s consideration of the Smithson arbitration was proper: (1) the arbitration

panel found that Hess had negotiated lower fixed prices for its CO2 purchases and

then had used those lower prices to value the CO2 for royalty purposes; (2) Hess “had

the full opportunity to challenge and offer alternatives to the method the arbitration

panel used to calculate value and damages”; and (3) the arbitration panel “used a

formula price that took into account Hess’s argument for a flat price,” as well as the

suggestions of Hess’s valuation specialist. Id. at 236–37.

The Director also explained why Hess’s Unit Average could not be used to

determine the value of Hess’s CO2 production: (1) it was “extremely difficult to

verify the prices under the Unit Average are consistent with federal valuation

requirements”; (2) the Unit Average “results in a value that is less than the price Hess

is willing to pay for CO2”; and (3) the Unit Average likely included prices from

non-arm’s-length CO2 sales. Id. at 234–36, 253. The Director observed that ONRR

and New Mexico had provided Hess ample notice through correspondence that the

26
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 27

agency was considering a different valuation method than the Unit Average. New

Mexico sent Hess two audit letters indicating that the Unit Average was not an

appropriate basis for Hess to use to value its federal CO2 production, to which Hess

responded. Id. at 238.

The Director further concluded that ONRR never had demanded that Hess use

the Unit Average valuation in perpetuity, as Hess seemed to claim. Id. at 248–53.

Hess argued that ONRR consistently had required Hess to use the Unit Average to

value its CO2 and that the Unit Average originated from an Amoco proposal to

ONRR on how Amoco should value its federal CO2 production from the Unit. Id.

at 248. The Director examined the sources on which Hess relied and explained in

detail that they did not amount to the agency’s endorsement of the Unit Average, but

to the extent they did, any such guidance was based on the facts presented at the time

and did not bind the agency to the Unit Average methodology decades later. Id.

at 248–53.

After analyzing the reasonableness of ONRR’s valuation under the Lease

valuation factors and rejecting the Unit Average, the Director determined that “the

result would be the same even if the federal gas royalty valuation regulations

controlled the outcome of this case.” Id. at 239 (citing 30 C.F.R. § 206.152(c)(2)).

The Director considered ONRR’s valuation under each of the second benchmark

regulatory factors:

(1) The Gross Proceeds Under Arm’s-Length Contracts for Like-Quality
Gas in the Same Field or Nearby Fields or Areas: ONRR considered
the gross proceeds under arm’s-length contracts for like quality gas,

27
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 28

including the arm’s-length Fasken Contract. The Fasken Contract was
the only contract in the record that ONRR could verify as an
arm’s-length contract. The Director concluded that ONRR had properly
considered this factor.

(2) Posted Prices: ONRR observed that the record did not include any
evidence of posted prices, so the agency could not evaluate this factor.
The Director concluded that ONRR had properly considered this factor.

(3) Prices Received in Arm’s-Length Spot Sales: ONRR observed that the
record did not include any evidence of prices received in arm’s-length
spot sales, so the agency could not evaluate this factor. The Director
concluded that ONRR had properly considered this factor.

(4) Other Reliable Public Sources of Price or Market Information:
ONRR considered the Smithson formula and Hess’s other settlements as
a means to determine value, but as discussed, it determined that the
Smithson formula was a more appropriate and reliable indicator of value
for the period of October 2003 through December 2008. The Director
concluded that ONRR had properly considered this factor.

(5) Other Information Particular to a Lease Operation or Saleability of
the Gas: Here ONRR considered the Hess Purchase Contracts and the
Unit Average that Hess had used as the basis for its royalty payments.
ONRR ultimately concluded that the Hess Purchase Contracts were a
more appropriate indicator of value than the Unit Average and used the
Hess Purchase Contracts as part of its final “weighted average”
valuation. The Director concluded that ONRR had properly considered
this factor.

Id. at 242–43. The Director concluded overall that ONRR had considered every

potential indicator of value in the record under the second regulatory benchmark.

On appeal, OXY raises three issues regarding ONRR’s valuation: (1) the

Director incorrectly concluded that ONRR’s valuation was reasonable under the

Lease valuation factors; (2) the Director improperly rejected Hess’s Unit Average as

the valuation method; and (3) the Director misapplied the 1988 regulatory factors to

alternatively affirm the agency’s valuation under the second regulatory benchmark.

28
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 29

1. Reasonableness of ONRR’s Valuation

OXY first argues that ONRR’s valuation is unreasonable and arbitrary. While

OXY does not provide any meaningful challenge to ONRR’s consideration of the

Fasken Contract or the Hess Purchase Contracts, OXY repeatedly asserts that

ONRR’s consideration of the Smithson formula was inappropriate because the

arbitration decision did not involve federal leases and only resolved a royalty dispute

between Hess and private lease owners. Aplt. Br. at 11–12, 45–47. In making this

argument, OXY contends that the Smithson formula never had been used to buy or

sell any CO2; the Smithson formula was not legally binding because the parties

settled after arbitration and the Smithson formula was not agreed to in the settlement;

arbitration awards and decisions have no precedential effect in other cases; and the

Smithson formula does not qualify as relevant evidence under the Lease valuation

factors or the 1988 regulatory factors. Id. at 46–49. Relatedly, OXY argues that if

the agency rejected the Unit Average due to the inclusion of non-arm’s-length

transactions, then it should not have considered the Smithson formula because it

included non-arm’s-length transactions. 12 Id. at 43, 49.

12
OXY also argues that ONRR’s valuation is arbitrary and inconsistent
because “[t]he history of this matter involves no less than four administrative
decisions differently valuing [Hess’s] Audit Period CO2 production.” Aplt. Br. at 19
(emphasis in original). OXY characterizes this history as “a vacillating scattershot of
substitute methodologies to re-value [Hess’s CO2 production].” Id. In actuality,
OXY is referencing the aforementioned correspondence that occurred among New
Mexico, ONRR, and Hess during the audit process, and as discussed, the record
shows that ONRR only issued one Order to Report and Pay Additional Royalties on
29
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 30

We conclude that the Director considered all relevant evidence and provided

sufficient reasoning for each of ONRR’s determinations regarding the valuation.

Under the deferential APA standard, we ask whether the agency’s decision was based

on an examination of the relevant evidence and if the agency “articulated a rational

connection between the facts found and the decision made.” Payton, 337 F.3d

at 1168. The Director’s methodology and detailed explanations certainly pass muster

under the APA’s deferential framework. The agency considered all relevant

information that was reasonably available, including the single arm’s-length Fasken

Contract, the Hess Purchase Contracts, and the Smithson formula for production

occurring between October 2003 and March 2008. ROA, at 233–37. The Director

then articulated a rational connection between the relevant information and ONRR’s

valuation under the Lease valuation factors and weighed the factors accordingly. Id.

The Director then analyzed the second regulatory benchmark factors at length and

explained why the result would be the same if the regulatory valuation factors

applied. Echoing the district court, we cannot reweigh the evidence, which seems to

be what OXY is requesting.

As to the Smithson formula, the agency was clear that consideration of this

formula was appropriate because the question under both Hess’s Leases and the 1988

regulations—the reasonable value of Hess’s CO2 based on all relevant and reliable

December 19, 2011, which ONRR’s Director then reduced in OXY’s favor on
review. See ROA, at 217–54, 270–82.

30
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 31

information—was fundamentally the same inquiry that the Smithson arbitration panel

conducted. During the audit, the agency discovered that Hess did not have other

reliable public sources of price or market information for the audit period, except for

the negligible Fasken Contract. The agency realized that the Smithson formula

provided an appropriate and reliable indicator of value from October 2003 through

December 2008 and therefore considered the formula in its analysis of “other

relevant matters” under the Lease valuation factors, as well as under “other reliable

public sources of price or market information” in its alternative analysis of the 1988

regulatory factors. Id. at 227–39, 242–43. As the Director explained, the formula

was the result of a neutral arbitration panel with full transparency into the basis for

the formula price, whereas Hess’s other settlement agreements did not “provide any

information on what was at issue, how the parties came to the formula price, or how

that price pertains to Hess’s CO2 purchases or sales.” Id. at 236. Moreover, the

arbitration panel set the formula price by blending two valuation methodologies

based on expert testimony proffered by each of the parties, and the formula reflected

“market conditions in the fall of 2003, [and] historical contracting practices.” Id.

at 230–37. It was proper for the agency to rely on the Smithson formula, not for its

precedential value, but rather for the relevant and reliable information it provided

about Hess’s CO2 purchase contracts, pricing mechanisms, and historical contracting

practices from this time.

OXY also contends that the Director’s decision to consider ONRR’s valuation

under the Lease valuation factors, instead of only the 1988 regulatory factors,

31
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 32

warrants reversal because this court’s affirmance “would inject substantial

uncertainty to royalty valuation for thousands of similarly-situated federal oil and gas

[standard-form] leases” and the 1988 regulations “cabin ONRR’s ability to substitute

its own royalty value.” Aplt. Br. at 21–31; Aplt. Reply Br. at 4–5. But the Director’s

decision was clear that it analyzed ONRR’s valuation in OXY’s case under the Lease

valuation factors because the specific Bravo Dome Unit Agreement controlled: The

Secretary “retained the right to establish a minimum value for federal CO2 production

in the Unit in its approval of the [Bravo Dome] Unit Agreement,” which modified

Hess’s underlying standard-form Leases to the extent they were inconsistent with the

Unit Agreement. ROA, at 227–28, 424. The Director applied this same logic to

reduce the pressure base calculation in accordance with the Unit Agreement in

OXY’s favor, which OXY does not dispute. Id. at 247–48. Further, any such

procedural inconsistency authorizing the Secretary to determine royalty valuation in

the first instance in OXY’s case ultimately is irrelevant because (1) the Director

reasonably articulated why the Unit Average is unreliable and (2) the Director

independently analyzed ONRR’s valuation under the second regulatory benchmark in

the alternative and came to the same conclusion. The Director also noted that while

the Order had not explicitly mentioned the Lease valuation factors in its analysis of

the second regulatory benchmark, the valuation factors overlapped, so the agency had

thoroughly considered the Lease valuation factors in the process of analyzing the

second regulatory benchmark. Id. at 228–38.

32
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 33

Because the Director weighed the relevant factors and evidence and adequately

explained the agency’s decision, ONRR’s valuation is not arbitrary or capricious.

2. Unit Average Valuation

OXY next argues that the Director improperly rejected Hess’s Unit Average as

the valuation method. OXY asserts that ONRR previously had approved the Unit

Average, and while ONRR is not estopped from conducting audits or reexamining a

valuation methodology, the Director’s decision and administrative record do not

clearly support a reversal of the Unit Average. ONRR merely substituted its own

methodology for the Unit Average “to extract more royalty dollars” without actually

finding that the Unit Average was inconsistent with the regulations. Aplt. Br. at 17.

OXY contends that ONRR instead should have conducted additional investigation

into the pricing practices of other Unit entities before rejecting the Unit Average. Id.

at 36–46.

We conclude that the Director’s decision to reject the Unit Average valuation

methodology is not arbitrary or capricious. In order for this court to reverse ONRR’s

decision, we would have to conclude that the agency failed to consider an important

aspect of the problem, offered an explanation for its decision that runs counter to the

evidence before the agency, or failed to base its decision on consideration of the

relevant factors. Utah Env’t Cong., 479 F.3d at 1280. The record presented does not

support our reaching any of these conclusions in this case. ONRR provided a

reasoned basis for rejecting the Unit Average price methodology under the applicable

regulations. ROA, at 234–36. ONRR’s justifications collectively reinforce each

33
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 34

other: It was reasonable for ONRR to determine that the Unit Average—comprised

primarily of non-federal lessees that are not subject to ONRR’s regulations or

oversight mechanisms, that ONRR cannot audit, and that use valuation

methodologies both largely unknown to ONRR and likely based at least in part on

non-arm’s-length sales—was not an appropriate measure of value, particularly since

the Unit Average resulted in a price lower than the Hess Purchase Contracts that

ONRR was able to examine.

The Director also explained in detail why any previous guidance or orders

Hess received (namely 1980s-era correspondence between Amoco and the Minerals

Management Service) that supported Hess using the Unit Average to calculate its

royalties on its federal CO2 production were not germane. Id. at 248–53. As ONRR

points out, none of the guidance OXY invokes had the force of law or was otherwise

binding on the agency. Aple. Br. at 31–37. And even if OXY was correct that

ONRR’s rejection of the Unit Average here conflicts with prior agency policy,

nothing prevented ONRR from changing its position so long as it provided a

reasonable explanation for doing so—and ONRR plainly provided a reasonable

explanation for rejecting the Unit Average.

The agency’s decision to reject the Unit Average is supported by substantial

evidence and is not arbitrary or capricious.

3. Second Regulatory Benchmark

OXY then argues that the Director misapplied the 1988 regulatory factors to

alternatively affirm the agency’s valuation under the second regulatory benchmark.

34
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 35

Here, OXY’s challenge focuses on the district court’s analysis, rather than

maintaining the required focus on the Director’s analysis under the APA. Aplt. Br.

at 32–36. In affirming the Director’s alternative analysis under the 1988 regulatory

factors, the district court stated that it “[would] not second-guess the Director’s

decision in weighing the regulatory factors where the Director considered and

analyzed the relevant factors and evidence.” ROA, at 87 (emphasis added). OXY

takes issue with this statement because the district court “overlook[ed] the threshold

point that the Director had no occasion to second-guess Hess’[s] valuation in the first

instance.” Aplt. Br. at 35.

OXY’s assertion is plainly wrong under the 1988 regulations, as well as the

Unit Agreement and underlying Leases. Under the 1988 regulations, ONRR is

required to audit the valuations that lessees supply and provide reasons for rejecting a

lessee’s application of the regulatory benchmarks. 30 U.S.C. § 1711(c). Under the

Unit Agreement and Leases, their terms dictate that ONRR retains the authority to

establish a reasonable minimum valuation in accordance with the Lease valuation

factors. ROA, at 442b, 446b, 450b, 454b [Sec. 2(d)(2)]. As demonstrated, ONRR

did that here. Id. at 242–43. Moreover, we use ordinary APA deference principles to

review the Director’s reasons for rejecting Hess’s Unit Average and approving

ONRR’s valuation under the second regulatory benchmark. We cannot reweigh the

regulatory factors if substantial evidence supports the Director’s reasoning—we

cannot even displace ONRR’s choice “between two fairly conflicting views, even

though the court would justifiably have made a different choice had the matter been

35
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 36

before it de novo.” Wyo. Farm Bureau Fed’n, 199 F.3d at 1231 (internal citations

omitted).

Because the record reveals substantial evidence in support of the Director’s

analysis of the regulatory valuation factors, the Director’s decision to alternatively

affirm the agency’s valuation under the second regulatory benchmark is not arbitrary

or capricious.

B. Transportation Costs

The final issue OXY raises is whether the Director correctly determined that

Hess’s compression and dehydration costs are not deductible as a transportation

allowance because they were necessary to place Hess’s CO2 in marketable condition and

not just transport the CO2. 13 ONRR regulations allow a lessee to deduct some, but not

all, of the costs of transporting the gas from the lease to a downstream location.

30 C.F.R. § 206.156(a). Under ONRR regulations and the relevant case law, a reasonable

minimum value will not include any costs that a lessee must incur to place gas in

marketable condition. See § 206.152(i); see, e.g., Devon Energy Corp., 551 F.3d

at 1036–40; Amoco Prod. Co., 410 F.3d at 729–31; Amerada Hess Corp. v. Dep’t of the

Interior, 170 F.3d 1032, 1036–37 (10th Cir. 1999); Mesa Operating Ltd P’ship v. Dep’t

13
We note that while the Order appears to deduct “some transportation costs”
from both the “weighted average” and the Smithson formula price, the Order
explicitly disallows Hess’s reported costs associated with compression and
dehydration that are at issue here. ROA, at 253. OXY only challenges the agency’s
denial of these compression and dehydration costs as a transportation allowance and
does not discuss or challenge any other transportation costs that the Order deducted
from its valuation.

36
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 37

of the Interior, 931 F.2d 318, 323–27 (5th Cir. 1991). Hess, as lessee, was responsible

for the costs to gather, compress, dehydrate, and remove any impurities from the CO2 to

meet marketable condition requirements. However, the regulations allow a lessee to

include “[s]upplemental costs for compression, dehydration, and treatment of gas . . .

only if such services [1] are required for transportation and [2] exceed the services

necessary to place production into marketable condition.” § 206.157(f)(9) (emphasis

added). So if Hess’s compression and dehydration costs (1) were required for

transportation and (2) exceeded what was necessary to compress and dehydrate the CO2

to place it in marketable condition, Hess could claim those costs as a transportation

allowance.

As the Director discussed, 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.” § 206.151. The

Director noted that “treating gas to put it in marketable condition includes gathering

(transporting gas from individual wells to a central accumulation point . . . on or near the

lease or unit), compression (increasing the pressure of gas), dehydration (removing

water), and sweetening (removing acid gases, such [sic] CO2 and hydrogen sulfide

(H2S)).” ROA, at 244–45 (citing relevant case law). In the context of Hess’s CO2

production, the Director interpreted this marketable-condition rule as requiring Hess to

treat its CO2 to conform with the pipeline requirements that served the markets into

which the CO2 was sold—the Permian Basin EOR units. Id. To meet the pressure and

quality requirements of the Permian Basin EOR units, treatment included compressing

37
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 38

and dehydrating the CO2 to meet specifications regarding water vapor, hydrogen sulfide,

sulfur, oxygen, nitrogen, and hydrocarbons. Id. at 245–46 (citing the terms of the Hess

Purchase Contracts). The Director determined that “[b]ecause the ultimate use of Hess’s

CO2 production is to inject the CO2 into the EOR facility, the EOR Delivery Pipelines

represent the pressure and quality requirements for Hess’s CO2 to be in marketable

condition.” Id. at 246. Accordingly, ONRR correctly concluded that Hess could not

deduct the costs it incurred to get the CO2 to the pressure and purity specifications

required to enter the EOR delivery pipelines. Id.

The Director also acknowledged Hess’s argument that the compression costs were

necessary for transport as well but explained that “even though the compressors operate

to put the CO2 in a super critical state for transportation, they also operate to place the

CO2 in marketable condition.” Id. The Director noted that such dual-purpose costs are

deductible “only if such services are required for transportation and exceed the services

necessary to place production into marketable condition,” which Hess did not establish.

Id. at 246–47 (citing § 206.157(f)(9)) (quotations omitted).

OXY responds that CO2 is “different from other produced federal gas” and has a

“unique nature,” so “[c]ertain dehydration and compression costs are essential for CO2

transportation from the [Unit] Leases to its destination in West Texas, and therefore are

properly deductible.” Aplt. Br. at 49; Aplt. Reply Br. at 18–19. OXY contends that the

real issue is “whether transportation is the primary, not the only, reason for dehydrating

and compressing [its CO2].” Aplt. Br. at 49.

38
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 39

But the Director already addressed and rejected OXY’s transportation arguments

based on the applicable regulations and case law and in the process explained why the

regulations do not embrace such a distinction. 14 ROA, at 243–47. We may reject the

Director’s interpretation and application of the marketable-condition rule to this case only

when the interpretation is “unreasonable, plainly erroneous, or inconsistent with the

regulation’s plain meaning.” Biodiversity Conservation All., 762 F.3d at 1060. The

regulations dictate that “costs for compression, dehydration, and treatment of gas” may

be deducted only to the extent “such services [1] are required for transportation and

[2] exceed the services necessary to place production into marketable condition.”

§ 206.157(f)(9). Contrary to OXY’s claims, Hess’s compression and dehydration costs

are not “unique costs related to transportation.” Aplt. Br. at 50. For CO2 to be

compatible with EOR operations, operators must remove impurities from the CO2 and

increase the gas’s pressure to transform it into a critical phase—essentially, the increased

pressure liquefies the CO2 so it can be injected at the EOR units. ROA, at 223–24. These

compression and dehydration costs are essential to bringing Hess’s CO2 to market for its

ultimate use in the EOR operations, even if they serve the dual purpose of helping

transport the gas.

14
The sources OXY cites similarly do not support its “primary purpose” theory.
Aplt. Br. at 49–53 (citing Shell Offshore Inc., 142 IBLA 71, 74 (1997) (allowing the
enlargement of a floating drilling platform to buoy a compressor and other gas
transportation equipment to be a transportation allowance under § 206.157) and Exxon
Corp., 118 IBLA 221, 240–41 (1991) (allowing dehydration of gas streams to be a
transportation allowance under § 206.157 because the dehydration in this instance
“serve[d] only one purpose: transportation”)).

39
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 40

Furthermore, OXY never has demonstrated or even contended that the costs to

transport Hess’s CO2 exceeded the costs necessary to meet the minimum pressure

requirements for the EOR delivery pipelines, let alone attempted to quantify the amount

of any excess costs. And a review of the record reveals that the ultimate compression

required for transport along the pipelines to the EOR units was less than the compression

required to enter the EOR facilities. 15 As a result, OXY has not shown that the

transportation costs “exceed[ed] the services necessary to place production into

marketable condition.” § 206.157(f)(9).

OXY also asserts that the record shows ONRR allowed Hess to deduct these

compression and dehydration costs as transportation costs in the past, citing a 2002

guidance letter from ONRR. ROA, at 412–14. But as ONRR points out, this letter does

not support OXY’s claim that compression costs are deductible whenever they are

“primarily required to place the CO2 into single phase to enter a large pipeline for long

distance transport to a delivery point remote from the lease (in West Texas).” Aplt. Br.

at 52. Rather, the letter explains that a deduction is permitted only if “this compression is

solely to keep the CO2 in single-phase flow for transportation through a large diameter

pipeline to a sales point remote from the lease.” ROA, at 413 (emphasis added). And

“[i]f compression is performed to place the CO2 in marketable condition,” as OXY does

15
As OXY discusses in its briefing, Hess had to compress the CO2 to upwards of
2,500 psig to enter the EOR facilities and therefore be in marketable condition. Aplt. Br.
at 9. But Hess only had to compress the CO2 to a maximum of 2,150 psig to transport the
CO2 to the EOR facilities along the pipelines. Id.; see also ROA, at 221–22.

40
Appellate Case: 21-2011 Document: 010110678144 Date Filed: 05/02/2022 Page: 41

not dispute is the case here, ONRR “will not allow any deductions for compression.” 16

Id.

The Director’s interpretation and application of the marketable-condition rule to

this case is not plainly erroneous or inconsistent with the applicable regulations.

IV

For the foregoing reasons, we AFFIRM.

16
OXY also argues in passing that the Director erred by relying on the regulations
to deny transportation cost deductions because the Director had valued the CO2 under the
Lease valuation factors. Aplt. Br. at 14, 16–17. However, as the district court observed,
the Director’s approach is consistent with the regulations. The regulations provide that
they should apply to the extent they are not inconsistent with the terms of the underlying
lease. 30 C.F.R. § 206.150(b). Because OXY has not pointed to any term of the Unit
Agreement or Leases inconsistent with the regulation’s marketable-condition rule, the
Director appropriately applied the regulations.

41