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Indep Petro Assn v. DeWitt, Wallace P.

Court: Court of Appeals for the D.C. Circuit
Date filed: 2002-02-08
Citations: 279 F.3d 1036
Copy Citations
15 Citing Cases
Combined Opinion
                  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.