The definitions in this section do not apply to subparts B, E, F and J of this part.

Actual cost means a cost incurred by a lessee. Actual costs do not include imputed costs, theoretical costs, or avoided costs.

Affiliate means a person who controls, is controlled by, or is under common control with another person. For the purposes of this subpart:

(1) Ownership or common ownership of more than 50 percent of the voting securities, or instruments of ownership or other forms of ownership, of another person constitutes control. Ownership of less than 10 percent constitutes a presumption of non-control that ONRR may rebut.

(2) If there is ownership or common ownership of 10 through 50 percent of the voting securities or instruments of ownership, or other forms of ownership, of another person, ONRR will consider each of the following factors to determine if there is control under the circumstances of a particular case:

(i) The extent to which there are common officers or directors.

(ii) With respect to the voting securities, or instruments of ownership or other forms of ownership: The percentage of ownership or common ownership, the relative percentage of ownership or common ownership compared to the percentage(s) of ownership by other persons, if a person is the greatest single owner, or if there is an opposing voting bloc of greater ownership.

(iii) Operation of a lease, plant, pipeline, or other facility.

(iv) The extent of other owners' participation in operations and day-to-day management of a lease, plant, or other facility.

(v) Other evidence of power to exercise control over or common control with another person.

(3) Regardless of any percentage of ownership or common ownership, relatives, either by blood or marriage, are affiliates.

Alternative in-service date means the date selected under § 1206.112(i)(1)(i) for Federal oil, § 1206.154(i)(1)(i) or § 1206.161(h)(1)(i) for Federal gas, or § 1206.259(b)(2)(v)(B)(1) or § 1206.262(b)(2)(v)(B)(1) for Federal coal from which the lessee will apply its depreciation schedule in calculating non-arm's-length allowance. The term “alternative in-service date” has no meaning outside of the commodities and regulations mentioned.

ANS means Alaska North Slope.

Area means a geographic region at least as large as the limits of an oil and/or gas field, in which oil and/or gas lease products have similar quality and economic characteristics. Area boundaries are not officially designated, and the areas are not necessarily named.

Arm's-length-contract means a contract or agreement between independent persons who are not affiliates and who have opposing economic interests regarding that contract. To be considered arm's-length for any production month, a contract must satisfy this definition for that month, as well as when the contract was executed.

Audit means an examination, conducted under the generally accepted Governmental Auditing Standards, of royalty reporting and payment compliance activities of lessees, designees or other persons who pay royalties, rents, or bonuses on Federal leases or Indian leases.

BIA means the Bureau of Indian Affairs of the Department of the Interior. ( printed page 39774)

BLM means the Bureau of Land Management of the Department of the Interior.

BOEM means the Bureau of Ocean Energy Management of the Department of the Interior.

BSEE means the Bureau of Safety and Environmental Enforcement of the Department of the Interior.

Capital cost means the actual cost associated with the initial purchase or construction of a fixed asset with a useful life greater than one year. Actual costs incurred to improve a fixed asset, enhance or modify a fixed asset's functionality, or extend the useful life of a fixed asset are also capital costs when the economic benefits of the changes extend beyond one year. Capital costs include those costs reasonable and necessary to bring the fixed asset to the condition and location of its intended use, such as shipping, delivery, and installation cost. The capital cost of a fixed asset reflects its value when measured at the in-service date.

Compression means the process of raising the pressure of gas.

Condensate means liquid hydrocarbons (normally exceeding 40 degrees of API gravity) recovered at the surface without processing. Condensate is the mixture of liquid hydrocarbons resulting from condensation of petroleum hydrocarbons existing initially in a gaseous phase in an underground reservoir.

Constraint means a reduction in, or elimination of, gas flow, deliveries, or sales required by the delivery system.

Contract means any oral or written agreement, including amendments or revisions, between two or more persons, that is enforceable by law and that, with due consideration, creates an obligation.

Depreciation means the systematic and rational allocation of the capital cost less a reasonable salvage value of a fixed asset to expense during periods when economic benefits are available to obtain from the fixed asset. Depreciation begins at the in-service date.

Depreciation schedule means a document used to record and track depreciation for a fixed asset. A depreciation schedule includes a list of fixed assets that can be separately identified. Each fixed asset entry must include the capital cost, the in-service date, the method of depreciation elected, the salvage value, and either the useful life, units of production, or life of reserve. For fixed assets depreciated as a group, the depreciation schedule shall demonstrate, or allow for the calculation of, either the group's useful life, units of production, or life of the reserve. The depreciation schedule includes, or allows for the calculation of, depreciation expense during the reporting period and the undepreciated capital cost.

Designee means the person whom the lessee designates to report and pay the lessee's royalties for a lease.

Exchange agreement means an agreement where one person agrees to deliver oil to another person at a specified location in exchange for oil deliveries at another location. Exchange agreements may or may not specify prices for the oil involved. They frequently specify dollar amounts reflecting location, quality, or other differentials. Exchange agreements include buy/sell agreements, which specify prices to be paid at each exchange point and may appear to be two separate sales within the same agreement. Examples of other types of exchange agreements include, but are not limited to, exchanges of produced oil for specific types of crude oil (such as West Texas Intermediate); exchanges of produced oil for other crude oil at other locations (Location Trades); exchanges of produced oil for other grades of oil (Grade Trades); and multi-party exchanges.

FERC means Federal Energy Regulatory Commission.

Field means a geographic region situated over one or more subsurface oil and gas reservoirs and encompassing at least the outermost boundaries of all oil and gas accumulations known within those reservoirs, vertically projected to the land surface. State oil and gas regulatory agencies usually name onshore fields and designate their official boundaries. BOEM names and designates boundaries of OCS fields.

First-of-month convention means that depreciation begins on the first day of the month of the in-service date or alternative in-service date.

Fixed assets means tangible assets owned or controlled by a lessee that are used to produce or provide goods and services in the primary business activities of that entity. Fixed assets have a useful life greater than one year.

Gas means any fluid, either combustible or non-combustible, hydrocarbon or non-hydrocarbon, which is extracted from a reservoir, and which has neither independent shape nor volume but tends to expand indefinitely. It is a substance that exists in a gaseous or rarefied state under standard temperature and pressure conditions.

Gas plant products means separate marketable elements, compounds, or mixtures, whether in liquid, gaseous, or solid form, resulting from processing gas, excluding residue gas.

Gathering means:

1. For production from non-OCS leases, the movement of production from the well to the BLM-approved FMP for royalty measurement.

2. For production from OCS leases, the movement of production from the well to one of the following locations, whichever is nearest to the well:

(i) the first point at which the production from two or more wells accumulate;

(ii) the point at which the production of a well is first separated into discrete constituents; or

(iii) the boundaries of the lease.

Geographic region means, for Federal gas, an area at least as large as the defined limits of an oil and or gas field in which oil and/or gas lease products have similar quality and economic characteristics.

Gross proceeds means the total monies and other consideration accruing for the disposition of any of the following:

(1) Oil. Gross proceeds also include, but are not limited to, the following examples:

(i) Payments for services such as dehydration, marketing, measurement, or gathering which the lessee must perform at no cost to the Federal Government.

(ii) The value of services, such as saltwater disposal, that the producer normally performs but that the buyer performs on the producer's behalf.

(iii) Reimbursements for harboring or terminalling fees, royalties, and any other reimbursements.

(iv) Tax reimbursements, even though the Federal royalty interest may be exempt from taxation.

(v) Payments made to reduce or buy down the purchase price of oil produced in later periods by allocating such payments over the production whose price that the payment reduces and including the allocated amounts as proceeds for the production as it occurs.

(vi) Monies and all other consideration to which a seller is contractually or legally entitled but does not seek to collect through reasonable efforts.

(2) Gas, residue gas, and gas plant products. Gross proceeds also include, but are not limited to, the following examples:

(i) Payments for services such as dehydration, marketing, measurement, or gathering that the lessee must perform at no cost to the Federal Government.

(ii) Reimbursements for royalties, fees, and any other reimbursements.

(iii) Tax reimbursements, even though the Federal royalty interest may be exempt from taxation. ( printed page 39775)

(iv) Monies and all other consideration to which a seller is contractually or legally entitled but does not seek to collect through reasonable efforts.

Index means:

(1) For gas, the calculated composite price ($/MMBtu) of spot market sales that a publication that meets ONRR-established criteria for acceptability at the index pricing point publishes.

(2) For oil, the calculated composite price ($/barrel) of spot market sales that a publication that meets ONRR-established criteria for acceptability at the index pricing point publishes.

Index pricing point means any point on a pipeline for which there is an index, which ONRR-approved publications may refer to as a trading location.

Index zone means a field or an area with an active spot market and published indices applicable to that field or an area that is acceptable to ONRR under § 1206.141(d)(1).

Indian Tribe means any Indian Tribe, band, nation, pueblo, community, rancheria, colony, or other group of Indians for which any minerals or interest in minerals is held in trust by the United States or is subject to Federal restriction against alienation.

Individual Indian mineral owner means any Indian for whom minerals or an interest in minerals is held in trust by the United States or who holds title subject to Federal restriction against alienation.

In-service date means the earlier of the date when a fixed asset is placed in service or the date when a fixed asset is functionally ready and available for its intended use. When considering a group of fixed assets, the group in-service date is the in-service date for the primary functional fixed asset of the group.

Keepwhole contract means a processing agreement under which the processor delivers to the lessee a quantity of gas after processing equivalent to the quantity of gas that the processor received from the lessee prior to processing, normally based on heat content, less gas used as plant fuel and gas unaccounted for and/or lost. This includes, but is not limited to, agreements under which the processor retains all NGLs that it recovered from the lessee's gas.

Lease means any contract, profit-sharing arrangement, joint venture, or other agreement issued or approved by the United States under any mineral leasing law, including the Indian Mineral Development Act, 25 U.S.C. 2101-2108, that authorizes exploration for, extraction of, or removal of lease products. Depending on the context, lease may also refer to the land area that the authorization covers.

Lease products mean any leased minerals, attributable to, originating from, or allocated to a lease or produced in association with a lease.

Lessee means any person to whom the United States, an Indian Tribe, and/or individual Indian mineral owner issues a lease, and any person who has been assigned all or a part of record title, operating rights, or an obligation to make royalty or other payments required by the lease. Lessee includes any person who has an interest in a lease.

Life of the reserve means the estimated term over which the natural reserve provides an economic benefit. A life of the reserve estimate is based on a report from an unaffiliated or independent expert and clearly identifies the assumptions supporting the estimate. If a fixed asset services multiple reserves, the life of the reserve represents the average of the individual reserve life estimates. Life of the reserve is measured in, or is convertible into, months and is determined at or prior to the in-service date.

Like quality means similar chemical and physical characteristics.

Location differential means an amount paid or received (whether in money or in barrels of oil) under an exchange agreement that results from differences in location between oil delivered in exchange and oil received in the exchange. A location differential may represent all or part of the difference between the price received for oil delivered and the price paid for oil received under a buy/sell exchange agreement.

Market center means a major point that ONRR recognizes for oil sales, refining, or transshipment. Market centers generally are locations where ONRR-approved publications publish oil spot prices.

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 for Federal oil and gas.

Mine means an underground or surface excavation or series of excavations and the surface or underground support facilities that contribute directly or indirectly to mining, production, preparation, and handling of lease products.

Net output means the quantity of gas residue gas and each gas plant product that a processing plant produces.

Netting means reducing the reported sales value to account for an allowance instead of reporting the allowance as a separate entry on the Report of Sales and Royalty Remittance (Form ONRR-2014) or the Solid Minerals Production and Royalty Report (Form ONRR-4430).

NGLs means Natural Gas Liquids.

NYMEX price means the average of the New York Mercantile Exchange (NYMEX) settlement prices for light sweet crude oil delivered at Cushing, Oklahoma, calculated as follows:

(1) First, sum the prices published for each day during the calendar month of production (excluding weekends and holidays) for oil to be delivered in the prompt month corresponding to each such day.

(2) Second, divide the sum by the number of days on which those prices are published (excluding weekends and holidays).

Oil means a mixture of hydrocarbons that existed in the liquid phase in natural underground reservoirs, remains liquid at atmospheric pressure after passing through surface separating facilities, and is marketed or used as a liquid. Condensate recovered in lease separators or field facilities is oil.

ONRR means the Office of Natural Resources Revenue of the Department of the Interior.

ONRR-approved commercial price bulletin means a publication that ONRR approves for determining NGLs prices.

ONRR-approved publication means:

(1) For oil, a publication that ONRR approves for determining ANS spot prices or WTI differentials.

(2) For gas, a publication that ONRR approves for determining index pricing points.

Operating Expense means costs associated with the production or provision of goods and services by a business. Operating expenses are costs necessary for the company's normal, core business activities.

Outer Continental Shelf (OCS) means all submerged lands lying seaward and outside of the area of lands beneath navigable waters, as defined in section 2 of the Submerged Lands Act (43 U.S.C. 1301), and of which the subsoil and seabed appertain to the United States and are subject to its jurisdiction and control.

Overhead means the indirect costs of producing or providing goods and services. Overhead must be systematically and rationally allocated to the goods or services being produced or provided. Overhead is a cost necessary for the company's normal, core business activities.

Payor means any person who reports and pays royalties under a lease, regardless of whether that person is also a lessee. ( printed page 39776)

Person means any individual, firm, corporation, association, partnership, consortium, or joint venture (when established as a separate entity).

Processing means any process designed to remove elements or compounds (hydrocarbon and non-hydrocarbon) from gas, including absorption, adsorption, or refrigeration. Field processes which normally take place on or near the lease, such as natural pressure reduction, mechanical separation, heating, cooling, dehydration, and compression, are not considered processing. The changing of pressures and/or temperatures in a reservoir is not considered processing. The use of a Joule-Thomson (JT) unit to remove NGLs from gas is considered processing regardless of where the JT unit is located, provided that you market the NGLs as NGLs.

Processing allowance means a deduction in determining royalty value for the reasonable, actual costs the lessee incurs for processing gas.

Prompt month means the nearest month of delivery for which NYMEX futures prices are published during the trading month.

Quality differential means an amount paid or received under an exchange agreement (whether in money or in barrels of oil) that results from differences in API gravity, sulfur content, viscosity, metals content, and other quality factors between oil delivered and oil received in the exchange. A quality differential may represent all or part of the difference between the price received for oil delivered and the price paid for oil received under a buy/sell agreement.

Reserve means the estimated quantity of known accumulations of a natural resource anticipated to be commercially recoverable from a defined area under existing economic conditions and by established operating practices from a given date forward.

Residue gas means that hydrocarbon gas consisting principally of methane resulting from processing gas.

Rocky Mountain Region means the States of Colorado, Montana, North Dakota, South Dakota, Utah, and Wyoming, except for those portions of the San Juan Basin and other oil-producing fields in the “Four Corners” area that lie within Colorado and Utah.

Roll means an adjustment to the NYMEX price that is calculated as follows: Roll = .6667 × (P₀ −P₁) + .3333 × (P₀ −P₂), where: P₀ = the average of the daily NYMEX settlement prices for deliveries during the prompt month that is the same as the month of production, as published for each day during the trading month for which the month of production is the prompt month; P₁ = the average of the daily NYMEX settlement prices for deliveries during the month following the month of production, published for each day during the trading month for which the month of production is the prompt month; and P₂ = the average of the daily NYMEX settlement prices for deliveries during the second month following the month of production, as published for each day during the trading month for which the month of production is the prompt month. Calculate the average of the daily NYMEX settlement prices using only the days on which such prices are published (excluding weekends and holidays).

(1) Example 1. Prices in Out Months are Lower Going Forward: The month of production for which you must determine royalty value is December. December was the prompt month (for year 2011) from October 21 through November 18. January was the first month following the month of production, and February was the second month following the month of production. P₀, therefore, is the average of the daily NYMEX settlement prices for deliveries during December published for each business day between October 21 and November 18. P₁ is the average of the daily NYMEX settlement prices for deliveries during January published for each business day between October 21 and November 18. P₂ is the average of the daily NYMEX settlement prices for deliveries during February published for each business day between October 21 and November 18. In this example, assume that P₀ = $95.08 per bbl, P₁ = $95.03 per bbl, and P₂ = $94.93 per bbl. In this example (a declining market), Roll = .6667 × ($95.08−$95.03) + .3333 × ($95.08−$94.93) = $0.03 + $0.05 = $0.08. You add this number to the NYMEX price.

(2) Example 2. Prices in Out Months are Higher Going Forward: The month of production for which you must determine royalty value is November. November was the prompt month (for year 2012) from September 21 through October 22. December was the first month following the month of production, and January was the second month following the month of production. P₀, therefore, is the average of the daily NYMEX settlement prices for deliveries during November published for each business day between September 21 and October 22. P₁ is the average of the daily NYMEX settlement prices for deliveries during December published for each business day between September 21 and October 22. P₂ is the average of the daily NYMEX settlement prices for deliveries during January published for each business day between September 21 and October 22. In this example, assume that P₀ = $91.28 per bbl, P₁ = $91.65 per bbl, and P₂ = $92.10 per bbl. In this example (a rising market), Roll = .6667 × ($91.28−$91.65) + .3333 × ($91.28−$92.10) = (−$0.25) + (−$0.27) = (−$0.52). You add this negative number to the NYMEX price (effectively, a subtraction from the NYMEX price).

Sale means a contract between two persons where:

(1) The seller unconditionally transfers title to the oil, gas, or gas plant product to the buyer and does not retain any related rights, such as the right to buy back similar quantities of oil, gas, or gas plant product from the buyer elsewhere;

(2) The buyer pays money or other consideration for the oil, gas, or gas plant product; and

(3) The parties' intent is for a sale of the oil, gas, or gas plant product to occur.

Salvage value means the value net of disposal costs that the payor expects to realize at the end of the useful life of an asset. Salvage values are designed to minimize any gain or loss at the time of disposal. Salvage value is greater than or equal to zero. Salvage value is determined at or prior to the in-service date.

Section 6 lease means an OCS lease subject to section 6 of the Outer Continental Shelf Lands Act, as amended, 43 U.S.C. 1335.

Spot price means the price under a spot sales contract where:

(1) A seller agrees to sell to a buyer a specified amount of oil at a specified price over a specified period of short duration.

(2) No cancellation notice is required to terminate the sales agreement.

(3) There is no obligation or implied intent to continue to sell in subsequent periods.

Straight-line depreciation method means a method of depreciation that allocates capital costs evenly over the useful life of an asset or the life of the reserve. The rate of depreciation applicable to the reporting period under this method is determined by dividing the capital cost by the useful life of the fixed asset or the life of the reserve.

Trading month means the period extending from the second business day before the 25th day of the second calendar month preceding the delivery month (or, if the 25th day of that month is a non-business day, the second business day before the last business day preceding the 25th day of that ( printed page 39777) month) through the third business day before the 25th day of the calendar month preceding the delivery month (or, if the 25th day of that month is a non-business day, the third business day before the last business day preceding the 25th day of that month), unless the NYMEX publishes a different definition or different dates on its official website, www.cmegroup.com, in which case, the NYMEX definition will apply.

Transportation allowance means a deduction in determining royalty value for the reasonable, actual costs that the lessee incurs for moving:

(1) Oil to a point of sale or delivery off of the lease, unit area, or communitized area. The transportation allowance does not include gathering costs.

(2) Unprocessed gas, residue gas, or gas plant products to a point of sale or delivery off of the lease, unit area, or communitized area, or away from a processing plant. The transportation allowance does not include gathering costs.

Unit-of-production depreciation method means a method of depreciation that allocates capital cost based on the fixed asset's designed specifications and output parameters. The rate of depreciation applicable to the reporting period under this method is determined by dividing the capital cost by the units of production for which the fixed asset was designed.

Units of production means the machine-hours for which an asset was designed to operate or the units of output that an asset was designed to produce. The units of production for a group of fixed assets are the capital-cost-weighted average units of production of the fixed assets comprising the group. Units of production are determined at or prior to the in-service date.

Useful life means the term over which the asset provides an economic benefit. If a useful life is applied to a group of fixed assets, it is the capital-cost-weighted average useful life of the fixed assets comprising the group. Useful life is measured in, or is convertible into, months and is determined at or prior to the in-service date.

WTI differential means the average of the daily mean differentials for location and quality between a grade of crude oil at a market center and West Texas Intermediate (WTI) crude oil at Cushing published for each day for which price publications perform surveys for deliveries during the production month, calculated over the number of days on which those differentials are published (excluding weekends and holidays). Calculate the daily mean differentials by averaging the daily high and low differentials for the month in the selected publication. Use only the days and corresponding differentials for which such differentials are published.

(a) The value of oil under this section for royalty purposes is the gross proceeds accruing to you or your affiliate under the arm's-length contract less applicable allowances determined under § 1206.111 or § 1206.112. This value does not apply if you exercise an option to use a different value provided in paragraph (c)(1) or (c)(2)(i) of this section, or if one of the exceptions in paragraph (d) of this section applies. You must use this paragraph (a) to value oil when:

(c)

(1) If you enter into an arm's-length exchange agreement, or multiple sequential arm's-length exchange agreements, and following the exchange(s) that you or your affiliate sell(s) the oil received in the exchange(s) under an arm's-length contract, then you may use either paragraph (a) of this section or § 1206.102 to value your production for royalty purposes. If you fail to make the election required under this paragraph, you may not make a retroactive election.

(i) If you use paragraph (a) of this section, your gross proceeds are the gross proceeds under your or your affiliate's arm's-length sales contract after the exchange(s) occur(s). You must adjust your gross proceeds for any location or quality differential, or other adjustments, that you received or paid under the arm's-length exchange agreement(s). If ONRR determines that any arm's-length exchange agreement does not reflect reasonable location or quality differentials, ONRR may require you to value the oil under § 1206.102. You may not otherwise use the price or differential specified in an arm's-length exchange agreement to value your production.

(d) This paragraph contains exceptions to the valuation rule in paragraph (a) of this section. Apply these exceptions on an individual contract basis.

(1) In conducting reviews and audits, if ONRR determines that any arm's length sales contract does not reflect the total consideration actually transferred either directly or indirectly from the buyer to the seller, ONRR may require that you value the oil sold under that contract either under § 1206.102 or at the total consideration received.

(2) You must value the oil under § 1206.102 if ONRR determines that the value under paragraph (a) of this section does not reflect the reasonable value of the production due to either:

(i) Misconduct by or between the parties to the arm's-length contract; or

(ii) Breach of your duty to market the oil for the mutual benefit of yourself and the lessor.

This section explains how to value oil that you may not value under § 1206.101 or that you elect under § 1206.101(c)(1) to value under this section. First, determine if paragraph (a), (b), or (c) of this section applies to production from your lease, or if you may apply paragraph (d) or (e) with ONRR's approval.

(d) Unreasonable value. If ONRR determines that the NYMEX price or ANS spot price does not represent a reasonable royalty value in any particular case, ONRR may establish a reasonable royalty value based on other relevant criteria.

(e) Production delivered to your refinery and the NYMEX price or ANS spot price is an unreasonable value.

(1) Instead of valuing your production under paragraph (a), (b), or (c) of this section, you may apply to ONRR to establish a value representing the market at the refinery if:

(i) You transport your oil directly to your or your affiliate's refinery, or exchange your oil for oil delivered to your or your affiliate's refinery; and

(ii) You must value your oil under this section at the NYMEX price or ANS spot price; and

(iii) You believe that use of the NYMEX price or ANS spot price results in an unreasonable royalty value.

(2) You must provide adequate documentation and evidence demonstrating the market value at the refinery. That evidence may include, but is not limited to:

(i) Costs of acquiring other crude oil at or for the refinery; ( printed page 39778)

(ii) How adjustments for quality, location, and transportation were factored into the price paid for other oil;

(iii) Volumes acquired for and refined at the refinery; and

(iv) Any other appropriate evidence or documentation that ONRR requires.

(3) If ONRR establishes a value representing market value at the refinery, you may not take an allowance against that value under § 1206.113(b) unless it is included in ONRR's approval.

(a)

(1) ONRR may monitor, review, and audit the royalties that you report, and, if ONRR determines that your reported value is inconsistent with the requirements of this subpart, ONRR may establish a reasonable royalty value based on other relevant criteria.

(2) If ONRR directs you to use a different royalty value, you must either pay any additional royalties due, plus late payment interest calculated under §§ 1218.54 and 1218.102 of this chapter) or report a credit for—or request a refund of—any overpaid royalties.

(b) ONRR may examine whether your or your affiliate's contract reflects the total consideration transferred for Federal oil, either directly or indirectly, from the buyer to you or your affiliate. If ONRR determines that additional consideration beyond that reflected in the contract was transferred, or that any portion of the consideration was not included in gross proceeds reported, ONRR may establish a reasonable royalty value based on other relevant criteria.

(c) ONRR may establish a reasonable royalty value based on other relevant criteria if ONRR determines that the gross proceeds accruing to you or your affiliate under a contract do not reflect reasonable consideration because:

(1) There is misconduct by or between the contracting parties;

(2) You have breached your duty to market the oil for the mutual benefit of yourself and the lessor; or

(3) ONRR cannot determine if you properly valued your oil under § 1206.101 or § 1206.102 for any reason including—but not limited to—your or your affiliate's failure to provide documents that ONRR requests under 30 CFR part 1212, subpart B.

(d) You have the burden of demonstrating that your or your affiliate's contract is arm's-length.

(e) ONRR may require you to certify that the provisions in your or your affiliate's contract include all the consideration that the buyer paid to you or your affiliate, either directly or indirectly, for the oil.

(f)

(1) Absent contract revision or amendment, if you or your affiliate fail(s) to take proper or timely action to receive prices or benefits to which you or your affiliate are entitled, you must pay royalty based upon that obtainable price or benefit.

(2) If you or your affiliate apply in a timely manner for a price increase or benefit allowed under your or your affiliate's contract, but the purchaser refuses and you or your affiliate take reasonable documented measures to force purchaser compliance, you will not owe additional royalties unless or until you or your affiliate receive additional monies or consideration resulting from the price increase. You may not construe this paragraph to permit you to avoid your royalty payment obligation in situations where a purchaser fails to pay, in whole or in part or in a timely manner, for a quantity of oil.

(g)

(1) You or your affiliate must put all contracts, contract revisions, or amendments in writing, and all parties to the contract must sign the contract, contract revisions, or amendments.

(2) If you or your affiliate fail(s) to comply with paragraph (g)(1) of this section, ONRR may establish a reasonable royalty value based on other relevant criteria.

(3) This provision applies notwithstanding any other provisions in this title 30 to the contrary.

(a) * * *

(1) The movement to the sales point is not gathering;

(f) ONRR may direct you to modify your transportation allowance if:

(f)(2) ONRR determines that the consideration that you or your affiliate paid under an arm's-length transportation contract does not reflect the reasonable cost of the transportation because you breached your duty to market the oil for the mutual benefit of yourself and the lessor by transporting your oil at a cost that is unreasonably high; or

(b) * * *

(12) Flow assurance costs. You may deduct costs associated with ensuring the flow of oil through a pipeline. This includes, but is not limited to, flow assurance chemicals, pipeline pigging equipment, and heated pipelines. This does not include the cost of operations required for producing oil, such as, but not limited to, chemicals injected in the wellbore to bring production to the surface.

(13) OCS platform costs. You may deduct costs directly allocable to:

(i) Oil pumps used to deliver oil into the export pipeline leaving the platform.

(ii) Flow assurance as described in paragraph (12) of this section.

(iii) Platform space required to house equipment in paragraphs (i) and (ii) of this section.

(iv) Platform buoyancy required to support the weight of equipment in (i), (ii), and (iii).

(14) Costs to repair, replace, or restore operability of a plugged or damaged pipeline. You may deduct your reasonable actual costs for repairing, replacing, or restoring operability of a plugged or damaged pipeline. If you receive insurance compensation, you must reduce your allowance by the compensation received.

(c) * * *

(9) Any OCS platform costs not included in paragraph (b)(13) of this section.

(d) If you have no written contract for the arm's-length transportation of oil, you must propose to ONRR a method to determine the allowance using the procedures in § 1206.108(a). You may use that method to determine your allowance until ONRR issues its valuation determination.

(a) This section applies if you or your affiliate do(es) not have an arm's-length ( printed page 39779) transportation contract, including situations where you or your affiliate provide your own transportation services. You must calculate your transportation allowance based on your or your affiliate's reasonable, actual costs for transportation during the reporting period using the procedures prescribed in this section.

(b) You or your affiliate's actual costs may include the following:

(1) Operating expenses under paragraph (f) of this section,

(2) Overhead under paragraph (g) of this section.

(3) Either:

(i) Depreciation expense and a return on undepreciated capital costs under paragraph (i) of this section, or

(ii) A cost equal to a return on the initial depreciable capital costs of the transportation system under paragraph (j) of this section.

(iii) Once you have elected to use either method for a transportation system, you may not later elect to change to the other alternative without ONRR's approval. If ONRR accepts your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(4) The reporting period when you do not have an arm's-length transportation contract is the reporting month following the production month.

(c) To the extent not included in costs identified in paragraphs (e) through (g) of this section, if you or your affiliate incur(s) the following actual costs under your or your affiliate's non-arm's-length contract, you may include these costs in your calculations under this section:

(1) Fees paid to a non-affiliated terminal operator for loading and unloading of crude oil into or from a vessel, vehicle, pipeline, or other conveyance

(2) Transfer fees paid to a hub operator associated with physical movement of crude oil through the hub when you do not sell the oil at the hub; these fees do not include title transfer fees

(3) A volumetric deduction to cover shrinkage when high-gravity petroleum (generally in excess of 51° API) is mixed with lower gravity crude oil for transportation

(4) Fees paid to a non-affiliated quality bank administrator for administration of a quality bank

(5) The cost of carrying on your books as inventory a volume of oil that the pipeline operator requires you, as a shipper, to maintain—and that you do maintain—in the line as line fill; you must calculate this cost as follows:

(i) First, multiply the volume that the pipeline requires you to maintain—and that you do maintain—in the pipeline by the value of that volume for the current month calculated under § 1206.101 or § 1206.102, as applicable.

(ii) Second, multiply the value calculated under paragraph (c)(5)(i) of this section by the monthly rate of return, calculated by dividing the rate of return specified in paragraph (k) of this section by 12.

(6) Only OCS platform costs directly allocable to the following:

(i) Oil pumps used to deliver oil into the export pipeline leaving the platform.

(ii) Flow assurance as described in § 1206.111(b)(12).

(iii) Platform space required to house equipment in paragraphs (i) and (ii) of this section.

(iv) Platform buoyancy required to support the weight of equipment in (i), (ii), and (iii).

(d) You may not include in your transportation allowance:

(1) Any of the costs identified under § 1206.111(c); or

(2) Fees paid (either in volume or in value) for actual or theoretical line losses.

(3) Any cost as a deduction that duplicates all or part of any other cost that you use under this section.

(e) Allowable capital costs are those for fixed assets that are an integral part of the transportation system.

(f) Allowable operating expenses include the following:

(1) Operations supervision and engineering

(2) Operations labor

(3) Fuel

(4) Utilities

(5) Materials

(6) Ad valorem property taxes

(7) Rent

(8) Supplies

(9) Maintenance

(10) Maintenance labor

(11) Any other directly allocable and attributable operating expense that you can document

(g) Overhead directly attributable and allocable to the operation and maintenance of the transportation system is an allowable expense.

(h) State and Federal income taxes and severance taxes and other fees, including royalties, are not allowable expenses.

(i) To calculate depreciation expense and a return on undepreciated capital costs:

(1) Depreciation and a return on undepreciated capital costs are calculated from the in-service date.

(i) If you or prior owners never claimed an allowance that included depreciation expense and a return on undepreciated capital costs or a return on initial undepreciated capital costs for a fixed asset, you may propose an alternative in-service date under (i)(4) of this section.

(ii) The alternative in-service date must not extend beyond the in-service date as extended by the shorter of the useful life and the life of the reserve.

(iii) You may not select the unit-of-production method when applying an alternative in-service date.

(iv) The application of an alternative in-service date does not change the useful life or life of the reserve.

(2) You may elect to use either a straight-line depreciation method or you may elect to use a unit-of-production depreciation method to calculate depreciation expense except when the alternative in-service date is applied under paragraph (i)(1)(i) of this section.

(i) Depreciation expense using the straight-line depreciation method is the rate of depreciation from the in-service date through the end of the useful life or life of the reserves under the first-of-month convention.

(ii) Depreciation expense using units-of-production depreciation is the product of the rate of depreciation and the units of output produced in the reporting period.

(iii) You may choose to apply these depreciation methods individually to each fixed assets or group of fixed assets.

(iv) After you make an election, you may not change methods without ONRR's approval. If ONRR accepts your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(3) Lessees may include allowable depreciation expense for acquired fixed assets as part of a transportation allowance. If you have a depreciation schedule that the original transporter/lessee established in compliance with 30 CFR part 1206 for purposes of the allowance calculation, a change in ownership of a transportation system will not alter that depreciation schedule.

(4) Proposing a depreciation schedule to ONRR:

(i) If no depreciation schedule under 30 CFR part 1206 exists or has existed for an in-service fixed asset, you may propose to ONRR a depreciation schedule for your transportation allowance.

(ii) If the depreciation schedule for an in-service fixed asset does not comply with 30 CFR part 1206, you may propose to ONRR a depreciation ( printed page 39780) schedule for your transportation allowance.

(iii) ONRR will consider the following factors when reviewing a proposed depreciation schedule for approval:

(A) The lessee's or a prior owner's published capitalization policy, depreciation policy, fixed asset useful life policy, and any related policies in effect during the applicable period, when provided by the proposing lessee;

(B) Consistency with audited financial statements that have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), when supporting records and reconciliations are provided by the proposing lessee;

(C) Documents prepared in support of the recording and capitalization of fixed assets under U.S. GAAP, when provided by the proposing lessee;

(D) Purchase price allocation reports prepared in accordance with U.S. GAAP by independent experts, when provided by the proposing lessee;

(E) Practices typical of the industry; and

(F) Any information that ONRR deems relevant regarding the depreciation schedule.

(iv) You may use your proposed depreciation schedule to calculate a transportation allowance beginning with the production month following the month when ONRR received your proposal until ONRR accepts or rejects it. If ONRR rejects your proposed depreciation schedule, you must amend your Form ONRR-2014 for the months that you used the rejected method and pay any additional royalty due, plus late payment interest.

(5) You may depreciate a transportation system, with or without a change in ownership, only once.

(6) To calculate the return on undepreciated capital cost, you may use an amount equal to the undepreciated capital cost of the transportation system at the beginning of the reporting period multiplied by the rate of return that you determine under paragraph (k) of this section. After you have depreciated a transportation system to the reasonable salvage value, you may thereafter include in the allowance calculation a cost equal to the reasonable salvage value multiplied by a rate of return under paragraph (k) of this section.

(j) As an alternative to using depreciation expense and a return on undepreciated capital cost, as provided under paragraph (b)(3) of this section, you may use as a cost an amount equal to the allowable initial capital cost of the transportation system multiplied by the rate of return determined under paragraph (k) of this section. You may not include depreciation in your allowance.

(k) The rate of return is the industrial rate associated with Standard & Poor's BBB rating.

(1) You must use the monthly average BBB rate that Standard & Poor's publishes for the first month for which the allowance is applicable.

(2) You must re-determine the rate at the beginning of each subsequent calendar year.

(a) This section applies to unprocessed gas. Unprocessed gas is:

(1) Gas that is not processed;

(2) Any gas that you are not required to value under §  1206.142; or

(3) Any gas that you sell prior to processing based on a price per MMBtu or Mcf when the price is not based on the residue gas and gas plant products.

(b) The value of gas under this section for royalty purposes is the gross proceeds accruing to you or your affiliate under the first arm's-length contract less a transportation allowance determined under §  1206.152. This value does not apply if you exercise the option in paragraph (c) of this section. Unless you elect to value your gas under paragraph (c) of this section, you must use this paragraph (b) to value gas when:

(1) You sell under an arm's-length contract;

(2) You sell or transfer unprocessed gas to your affiliate or another person under a non-arm's-length contract and that affiliate or person, or an affiliate of either of them, then sells the gas under an arm's-length contract, unless you exercise the option provided in paragraph (c) of this section;

(3) You, your affiliate, or another person sell(s) unprocessed gas produced from a lease under multiple arm's-length contracts, and that gas is valued under this paragraph. Unless you exercise the option provided in paragraph (c) of this section, the value of the gas is the volume-weighted average of the values, established under this paragraph, for each contract for the sale of gas produced from that lease; or

(4) You or your affiliate sell(s) under a pipeline cash-out program. In that case, for over-delivered volumes within the tolerance under a pipeline cash-out program, the value is the price that the pipeline must pay you or your affiliate under the transportation contract. You must use the same value for volumes that exceed the over-delivery tolerances, even if those volumes are subject to a lower price under the transportation contract.

(c) Alternatively, you may elect to value your unprocessed gas under this paragraph (c), which allows you to use an index-based valuation method to calculate royalty value. You may not change your election more often than once every two years.

(1)

(i) If you can only transport gas to one index pricing point published in an ONRR-approved publication, available at www.onrr.gov, your value, for royalty purposes, is the published bidweek index price to which your gas may flow for that respective production month.

(ii) If you can transport gas to more than one index pricing point published in an ONRR-approved publication available at www.onrr.gov, your value, for royalty purposes, is the highest of the published bidweek index prices to which your gas may flow for that respective production month, whether or not there are constraints for that production month.

(iii) If there are sequential index pricing points on a pipeline, you must use the first index pricing point at or after your gas enters the pipeline.

(iv) You may adjust the number calculated under paragraphs (c)(1)(i) and (ii) of this section by reducing the value by 20 percent, but not more than 74 cents per MMBtu for sales from the OCS Gulf of America and by 13 percent, but not more than 45 cents per MMBtu, for sales from all other areas.

(v) After you select an ONRR-approved publication available at www.onrr.gov, you may not select a different publication more often than once every two years.

(vi) ONRR may exclude an individual index pricing point found in an ONRR-approved publication if ONRR determines that the index pricing point does not accurately reflect the values of production. ONRR will publish criteria for index pricing points available at www.onrr.gov.

(2) You may not take any other deductions from the value calculated under this paragraph (c).

(d) If some of your gas is used, lost, unaccounted for, or retained as a fee under the terms of a sales or service agreement, that gas will be valued for royalty purposes using the same royalty valuation method for valuing the rest of the gas that you do sell.

(e) If you have no written contract for the sale of gas or no sale of gas subject to this section and: ( printed page 39781)

(1) There is an index pricing point for the gas, then you must value your gas under paragraph (c) of this section; or

(2) There is not an index pricing point for the gas, then:

(i) You must propose to ONRR a method to determine the value using the procedures in § 1206.148(a).

(ii) You may use that method to determine value, for royalty purposes, until ONRR issues its decision.

(iii) After ONRR issues its valuation determination, you must make the adjustments under § 1206.143(a)(2).

(f) Under no circumstances may your gas be valued for royalty purposes less than zero.

(g) If you elect to value your gas under paragraph (c) of this section, ONRR reserves the right to collect actual transaction data in the future to assess the validity of the index-based valuation option.

(a) This section applies to the valuation of processed gas, including but not limited to:

(1) Gas that you or your affiliate do not sell, or otherwise dispose of, under an arm's-length contract prior to processing.

(2) Gas where your or your affiliate's arm's-length contract for the sale of gas prior to processing provides for payment to be determined based on the value of any products resulting from processing, including residue gas or natural gas liquids.

(3) Gas that you or your affiliate process under an arm's-length keepwhole contract.

(4) Gas where your or your affiliate's arm's-length contract includes a reservation of the right to process the gas, and you or your affiliate exercise(s) that right.

(b) The value of gas subject to this section, for royalty purposes, is the combined value of the residue gas and all gas plant products that you determine under this section plus the value of any condensate recovered downstream of the point of royalty settlement without resorting to processing that you determine under subpart C of this part less applicable transportation and processing allowances that you determine under this subpart, unless you exercise the option provided in paragraph (d) of this section.

(c) The value of residue gas or any gas plant product under this section for royalty purposes is the gross proceeds accruing to you or your affiliate under the first arm's-length contract. This value does not apply if you exercise the option provided in paragraph (d) of this section. Unless you exercise the option provided in paragraph (d) of this section, you must use this paragraph (c) to value residue gas or any gas plant product when:

(1) You sell under an arm's-length contract;

(2) You sell or transfer to your affiliate or another person under a non-arm's length contract, and that affiliate or person, or another affiliate of either of them, then sells the residue gas or any gas plant product under an arm's-length contract;

(3) You, your affiliate, or another person sell(s), under multiple arm's length contracts, residue gas or any gas plant products recovered from gas produced from a lease that you value under this paragraph. In that case, because you sold non-arm's-length to your affiliate or another person, the value of the residue gas or any gas plant product is the volume-weighted average of the gross proceeds established under this paragraph for each arm's-length contract for the sale of residue gas or any gas plant products recovered from gas produced from that lease; or

(4) You or your affiliate sell(s) under a pipeline cash-out program. In that case, for over-delivered volumes within the tolerance under a pipeline cash-out program, the value is the price that the pipeline must pay to you or your affiliate under the transportation contract. You must use the same value for volumes that exceed the over-delivery tolerances, even if those volumes are subject to a lower price under the transportation contract.

(d) Alternatively, you may elect to value your residue gas and/or NGLs under this paragraph (d). You may not change your election more often than once every two years.

(1)

(i) If you can only transport residue gas to one index pricing point published in an ONRR-approved publication available at www.onrr.gov, your value, for royalty purposes, is the published bidweek index price to which your gas may flow for that respective production month.

(ii) If you can transport residue gas to more than one index pricing point published in an ONRR-approved publication available at www.onrr.gov, your value, for royalty purposes, is the highest of the published bidweek index prices to which your gas may flow for that respective production month, whether or not there are constraints for that production month.

(iii) If there are sequential index pricing points on a pipeline, you must use the first index pricing point at or after your residue gas enters the pipeline.

(iv) You may adjust the number calculated under paragraphs (d)(1)(i) and (ii) of this section by reducing the value by 20 percent but not more than 74 cents per MMBtu for sales from the OCS Gulf of America and by 13 percent but not more than 45 cents per MMBtu for sales from all other areas.

(v) After you select an ONRR-approved publication available at www.onrr.gov, you may not select a different publication more often than once every two years.

(vi) ONRR may exclude an individual index pricing point found in an ONRR-approved publication if ONRR determines that the index pricing point does not accurately reflect the values of production. ONRR will publish criteria for index pricing points on www.onrr.gov.

(2)

(i) If you sell NGLs in an area with one or more ONRR-approved commercial price bulletins available at www.onrr.gov, you must choose one bulletin, and your value, for royalty purposes, is the monthly average price for that bulletin for the production month.

(ii) You must reduce the number calculated under paragraph (d)(2)(i) of this section by the amounts that ONRR posts at www.onrr.gov for the geographic location of your lease. The method that ONRR will use to calculate the amounts is set forth in the preamble to this regulation. This method is binding on you and ONRR. ONRR will update the amounts periodically using this method.

(iii) After you select an ONRR-approved commercial price bulletin available at www.onrr.gov, you must not select a different commercial price bulletin more often than once every two years.

(3) You may not take any other deductions from the value calculated under this paragraph (d).

(4) ONRR will post changes to any of the rates in this paragraph (d) on its website.

(e) If some of your gas or gas plant products are used, lost, unaccounted for, or retained as a fee under the terms of a sales or service agreement, that gas will be valued for royalty purposes using the same royalty valuation method for valuing the rest of the gas or gas plant products that you do sell. ( printed page 39782)

(f) If you have no written contract for the sale of gas or no sale of gas subject to this section and:

(1) There is an index pricing point or commercial price bulletin for the gas, then you must value your gas under paragraph (d) of this section.

(2) There is not an index pricing point or commercial price bulletin for the gas, then:

(i) You must propose to ONRR a method to determine the value using the procedures in § 1206.148(a).

(ii) You may use that method to determine value, for royalty purposes, until ONRR issues our decision.

(iii) After ONRR issues its valuation determination, you must make the adjustments under § 1206.143(a)(2).

(g) Under no circumstances may your gas be valued for royalty purposes less than zero.

(h) If you elect to value your gas under paragraph (d) of this section, ONRR reserves the right to collect actual transaction data in the future to assess the validity of the index-based valuation option.

(a)

(1) ONRR may monitor, review, and audit the royalties that you report. If ONRR determines that your reported value is inconsistent with the requirements of this subpart, ONRR will direct you to use a different measure of royalty value.

(2) If ONRR directs you to use a different royalty value, you must either pay any additional royalties due, plus late payment interest calculated under §§ 1218.54 and 1218.102 of this chapter, or report a credit for, or request a refund of, any overpaid royalties.

(b) ONRR may examine whether your or your affiliate's contract reflects the total consideration transferred for Federal gas, either directly or indirectly, from the buyer to you or your affiliate. If ONRR determines that additional consideration beyond that reflected in the contract was transferred, or that any portion of the consideration was not included in gross proceeds reported, ONRR may establish a reasonable royalty value based on other relevant criteria.

(c) ONRR may direct you to use a different measure of royalty value if ONRR determines that the gross proceeds accruing to you or your affiliate under a contract do not reflect reasonable consideration because:

(1) There is misconduct by or between the contracting parties;

(2) You have breached your duty to market the gas, residue gas, or gas plant products for the mutual benefit of yourself and the lessor by selling your gas, residue gas, or gas plant products at a value that is unreasonably low. ONRR may consider a sales price unreasonably low if it is 10 percent less than the lowest reasonable measures of market price, including, but not limited to, index prices and prices reported to ONRR for like-quality gas, residue gas, or gas plant products; or

(3) ONRR cannot determine if you properly valued your gas, residue gas, or gas plant products under § 1206.141 or § 1206.142 for any reason, including, but not limited to, your or your affiliate's failure to provide documents that ONRR requests under 30 CFR part 1212, subpart B.

(d) You have the burden of demonstrating that your or your affiliate's contract is arm's-length.

(e) ONRR may require you to certify that the provisions in your or your affiliate's contract include(s) all the consideration that the buyer paid to you or your affiliate, either directly or indirectly, for the gas, residue gas, or gas plant products.

(f)

(1) Absent contract revision or amendment, if you or your affiliate fail(s) to take proper or timely action to receive prices or benefits to which you or your affiliate are entitled, you must pay royalty based upon that obtainable price or benefit.

(2) If you or your affiliate make timely application for a price increase or benefit allowed under your or your affiliate's contract, but the purchaser refuses, and you or your affiliate take reasonable, documented measures to force purchaser compliance, you will not owe additional royalties unless or until you or your affiliate receive additional monies or consideration resulting from the price increase. You may not construe this paragraph to permit you to avoid your royalty payment obligation in situations where a purchaser fails to pay, in whole or in part, or in a timely manner, for a quantity of gas, residue gas, or gas plant products.

(g)

(1) You or your affiliate must make all contracts, contract revisions, or amendments in writing, and all parties to the contract must sign the contract, contract revisions, or amendments.

(2) If you or your affiliate fail(s) to comply with paragraph (g)(1) of this section, ONRR may direct you to use a different measure of royalty value.

(3) This provision applies notwithstanding any other provisions in this title 30 to the contrary.

(c) Your gas or gas plant products are in marketable condition when it meets the required quality specifications for either:

(1) Delivery to a Mainline Pipeline. If your gas or gas plant products are delivered to a mainline pipeline that transports gas to market, it must meet the quality specifications set by that pipeline operator. This is typically the specifications required for delivery at the outlet of a gas processing plant;

(2) Delivery other than Mainline Pipeline. If your gas or gas plant products are delivered to market by means other than through a mainline pipeline, then your gas is in marketable condition when it meets the specifications required by the receiving transporter or purchaser; or

(3) Alternative Market for Unprocessed Gas. If your gas is never processed and you can reasonably support that a market exists at another location, you can use the quality specifications required at that alternative delivery point.

(a) * * *

(2) The movement to the sales point is not gathering.

(g) ONRR may direct you to modify your transportation allowance if:

(1) * * *

(2) ONRR determines that the consideration that you or your affiliate paid under an arm's-length transportation contract does not reflect the reasonable cost of the transportation because you breached your duty to market the gas, residue gas, or gas plant products for the mutual benefit of yourself and the lessor; or

(a)

(1) If you or your affiliate incur transportation costs under an arm's-length transportation contract, you may claim a transportation allowance for the reasonable, actual costs incurred, as more fully explained in paragraph (b) of this section, except as provided in § 1206.152(g) and subject to the limitation in § 1206.152(e).

(2) You must be able to demonstrate that your or your affiliate's contract is arm's-length.

(b) Subject to the requirements of paragraph (c) of this section, you may include, but are not limited to, the following costs to determine your transportation allowance under paragraph (a) of this section; you may not use any cost as a deduction that duplicates all or part of any other cost that you use under this section:

(1) Firm demand charges paid to pipelines. You may deduct firm demand charges or capacity reservation fees that you or your affiliate paid to a pipeline, including charges or fees for unused firm capacity that you or your affiliate have not sold before you report your allowance. If you or your affiliate receive(s) a payment from any party for release or sale of firm capacity after reporting a transportation allowance that included the cost of that unused firm capacity, or if you or your affiliate receive(s) a payment or credit from the pipeline for penalty refunds, rate case refunds, or other reasons, you must reduce the firm demand charge claimed on Form ONRR-2014 by the amount of that payment. You must modify Form ONRR-2014 by the amount received or credited for the affected reporting period and pay any resulting royalty due, plus late payment interest calculated under §§ 1218.54 and 1218.102 of this chapter.

(2) Gas Supply Realignment (GSR) costs. The GSR costs result from a pipeline reforming or terminating supply contracts with producers in order to implement the restructuring requirements of FERC Orders in 18 CFR part 284.

(3) Commodity charges. The commodity charge allows the pipeline to recover the costs of providing service.

(4) Wheeling costs. Hub operators charge a wheeling cost for transporting gas from one pipeline to either the same or another pipeline through a market center or hub. A hub is a connected manifold of pipelines through which a series of incoming pipelines are interconnected to a series of outgoing pipelines.

(5) Gas Research Institute (GRI) fees. The GRI conducts research, development, and commercialization programs on natural gas-related topics for the benefit of the U.S. gas industry and gas customers. GRI fees are allowable, provided that such fees are mandatory in FERC-approved tariffs.

(6) Annual Charge Adjustment (ACA) fees. FERC charges these fees to pipelines to pay for its operating expenses.

(7) Payments (either volumetric or in value) for actual or theoretical losses. Theoretical losses are not deductible in transportation arrangements unless the transportation allowance is based on arm's-length transportation rates charged under a FERC or State regulatory-approved tariff. If you or your affiliate receive(s) volumes or credit for line gain, you must reduce your transportation allowance accordingly and pay any resulting royalties plus late payment interest calculated under §§ 1218.54 and 1218.102 of this chapter.

(8) Temporary storage services. This includes short-duration storage services that market centers or hubs (commonly referred to as “parking” or “banking”) offer or other temporary storage services that pipeline transporters provide, whether actual or provided as a matter of accounting. Temporary storage is limited to 30 days or fewer.

(9) Supplemental costs for compression, dehydration, and treatment of gas. ONRR allows these costs only if such services are required for transportation and exceed the services necessary to place production into marketable condition required under § 1206.146.

(10) Costs of surety. You may deduct the costs of securing a letter of credit, or other surety, that the pipeline requires you or your affiliate, as a shipper, to maintain under a transportation contract.

(11) Hurricane surcharges. You may deduct hurricane surcharges that you or your affiliate actually pay(s).

(12) Flow assurance costs. You may deduct costs associated with ensuring the flow of gas through a pipeline. This includes, but is not limited to, flow assurance chemicals, pipeline pigging equipment, and heated pipelines. This does not include the cost of operations required for producing gas, such as, but not limited to, chemicals injected into the wellbore to bring production to the surface.

(13) OCS platform costs. You may deduct costs directly allocable to:

(i) Services described in paragraph (9) of this section.

(ii) Flow assurance as described in paragraph (12) of this section.

(iii) Platform space required to house equipment in paragraphs (i) and (ii) of this section.

(iv) Platform buoyancy required to support the weight of equipment in (i), (ii), and (iii).

(14) Costs to repair, replace, or restore operability of a plugged or damaged pipeline. You may deduct your reasonable actual costs for repairing, replacing, or restoring operability of a plugged or damaged pipeline. If you receive insurance compensation, you must reduce your allowance by the compensation received.

(c) You may not include the following costs to determine your transportation allowance under paragraph (a) of this section:

(1) Fees or costs incurred for storage. This includes storing production in a storage facility, whether on or off of the lease, for more than 30 days.

(2) Aggregator/marketer fees. This includes fees that you or your affiliate pay(s) to another person (including your affiliates) to market your gas, including purchasing and reselling the gas or finding or maintaining a market for the gas production.

(3) Penalties that you or your affiliate incur(s) as a shipper. These penalties include, but are not limited to:

(i) Over-delivery cash-out penalties. This includes the difference between the price that the pipeline pays to you or your affiliate for over-delivered volumes outside of the tolerances and the price that you or your affiliate receive(s) for over-delivered volumes within the tolerances.

(ii) Scheduling penalties. This includes penalties that you or your affiliate incur(s) for differences between daily volumes delivered into the pipeline and volumes scheduled or nominated at a receipt or delivery point.

(iii) Imbalance penalties. This includes penalties that you or your affiliate incur(s) (generally on a monthly basis) for differences between volumes delivered into the pipeline and volumes scheduled or nominated at a receipt or delivery point.

(iv) Operational penalties. This includes fees that you or your affiliate incur(s) for violation of the pipeline's curtailment or operational orders issued to protect the operational integrity of the pipeline.

(4) Intra-hub transfer fees. These are fees that you or your affiliate pay(s) to hub operators for administrative services (such as title transfer tracking) necessary to account for the sale of gas within a hub. ( printed page 39784)

(5) Fees paid to brokers. This includes fees that you or your affiliate pay(s) to parties who arrange marketing or transportation, if such fees are separately identified from aggregator/marketer fees.

(6) Fees paid to scheduling service providers. This includes fees that you or your affiliate pay(s) to parties who provide scheduling services, if such fees are separately identified from aggregator/marketer fees.

(7) Internal costs. This includes salaries and related costs, rent/space costs, office equipment costs, legal fees, and other costs to schedule, nominate, and account for the sale or movement of production.

(8) Other non-allowable costs. Any cost you or your affiliate incur(s) for services that you are required to provide at no cost to the lessor, including, but not limited to, costs to place your gas, residue gas, or gas plant products into marketable condition disallowed under § 1206.146 and costs of boosting residue gas disallowed under § 1202.151(b) of this chapter.

(9) Any OCS platform costs not included in paragraph (b)(13) of this section.

(d) If you have no written contract for the arm's-length transportation of gas, and neither you nor your affiliate perform your own transportation, you must propose to ONRR a method to determine the transportation allowance using the procedures in § 1206.148(a). You may use that method to determine your allowance until ONRR issues its valuation determination.

(a) This section applies if you or your affiliate do(es) not have an arm's-length transportation contract, including situations where you or your affiliate provide your own transportation services. You must calculate your transportation allowance based on your or your affiliate's reasonable, actual costs for transportation during the reporting period using the procedures prescribed in this section.

(b) Your or your affiliate's actual costs may include:

(1) Operating expenses under (f) of this section.

(2) Overhead under paragraph (g) of this section.

(3) Either:

(i) Depreciation expense and a return on undepreciated capital costs under paragraph (i) of this section, or

(ii) A cost equal to a return on the initial undepreciated capital cost of the transportation system under paragraph (j) of this section.

(iii) Once you have elected to use either method for a transportation system, you may not later elect to change to the other alternative without ONRR's approval. If ONRR accepts your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(4) The reporting period when you do not have an arm's-length transportation contract is the reporting month following the production month.

(c) To the extent not included in costs identified in paragraphs (e) through (g) of this section, if you or your affiliate incur(s) actual costs under your or your affiliate's non-arm's-length contract, you may include those costs in your calculations under this section:

(1) The actual transportation costs listed under § 1206.153(b)(2), (5), (6), (9), (12), and (14) of this subpart.

(2) Only OCS platform costs directly allocable to the following:

(i) Services described in § 1206.153(b)(9) of this section.

(ii) Flow assurance as described in § 1206.153(b)(12).

(iii) Platform space required to house equipment in paragraphs (i) and (ii) of this section.

(iv) Platform buoyancy required to support the weight of equipment in (i), (ii), and (iii).

(d) You may not include in your transportation allowance:

(1) Any of the non-allowable costs listed under § 1206.153(c).

(2) Fees paid (either in volume or in value) for actual or theoretical line losses.

(3) Any cost as a deduction that duplicates all or part of any other cost that you use under this section.

(e) Allowable capital costs are those for fixed assets that are an integral part of the transportation system.

(f) Allowable operating expenses include the following:

(1) Operations supervision and engineering

(2) Operations labor

(3) Fuel

(4) Utilities

(5) Materials

(6) Ad valorem property taxes

(7) Rent

(8) Supplies

(9) Maintenance

(10) Maintenance labor

(11) Any other directly allocable and attributable operating expense that you can document

(g) Overhead directly attributable and allocable to the operation and maintenance of the transportation system is an allowable expense.

(h) State and Federal income taxes and severance taxes and other fees, including royalties, are not allowable expenses.

(i) To calculate depreciation expense and a return on undepreciated capital costs:

(1) Depreciation and a return on undepreciated capital costs are calculated from the in-service date.

(i) If you or prior owners never claimed an allowance that included depreciation expense and a return from undepreciated capital costs or a return on initial undepreciated capital costs for a fixed asset, you may propose an alternative in-service date under (i)(4) of this section.

(ii) The alternative in-service date must not extend beyond the in-service date as extended by the shorter of the useful life and the life of the reserve.

(iii) You may not select the unit-of-production method when applying an alternative in-service date.

(iv) The application of an alternative in-service date does not change the useful life or life of the reserve.

(2) You may elect to use either a straight-line depreciation method or you may elect to use a unit-of-production method to calculate depreciation expense except when the alternative in-service date is applied under paragraph (i)(1)(i) of this section.

(i) Depreciation expense using the straight-line depreciation method is the rate of depreciation from the in-service date through the end of the useful life or life of the reserves under the first-of-month convention.

(ii) Depreciation expense using the units-of-production depreciation method is the product of the rate of depreciation and the units of output produced in the reporting period.

(iii) You may choose to apply these depreciation methods individually to each fixed asset or group of fixed assets.

(iv) After you make an election, you may not change methods without ONRR's approval. If ONRR accepts your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(3) Lessees may include allowable depreciation expense for acquired fixed assets as part of a transportation allowance. If you have a depreciation schedule that the original transporter/lessee established in compliance with 30 CFR part 1206 for purposes of the allowance calculation, a change in ownership of a transportation system ( printed page 39785) will not alter that depreciation schedule.

(4) Proposing a depreciation schedule to ONRR:

(i) If no depreciation schedule under 30 CFR part 1206 exists or has existed for an in-service fixed asset, you may propose to ONRR a depreciation schedule for your transportation allowance.

(ii) If the depreciation schedule for an in-service fixed asset does not comply with 30 CFR part 1206, you may propose to ONRR a depreciation schedule for your transportation allowance.

(iii) ONRR will consider the following factors when reviewing a proposed depreciation schedule for approval:

(A) The lessee's or a prior owner's published capitalization policy, depreciation policy, fixed asset useful life policy, and any related policies in effect during the applicable period, when provided by the proposing lessee;

(B) Consistency with audited financial statements that have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), when supporting records and reconciliations are provided by the proposing lessee;

(C) Documents prepared in support of the recording and capitalization of fixed assets under U.S. GAAP, when provided by the proposing lessee;

(D) Purchase price allocation reports prepared in accordance with U.S. GAAP by independent experts, when provided by the proposing lessee;

(E) Practices typical of the industry; and

(F) Any information that ONRR deems relevant regarding the depreciation schedule.

(5) You may depreciate a transportation system only once with or without a change in ownership.

(6) To calculate the return on undepreciated capital cost:

(i) You may use an amount equal to the undepreciated capital cost of the transportation system at the beginning of the reporting period multiplied by the rate of return that you determine under paragraph (k) of this section.

(ii) After you have depreciated a transportation system to the reasonable salvage value, you may thereafter include in the allowance calculation a cost equal to the reasonable salvage value multiplied by a rate of return under paragraph (k) of this section.

(j) As an alternative to using depreciation expense and a return on undepreciated capital cost, as provided under paragraph (b)(3) of this section, you may use as a cost an amount equal to the allowable initial capital cost of the transportation system multiplied by the rate of return determined under paragraph (k) of this section. You may not include depreciation in your allowance.

(k) The rate of return is the industrial rate associated with Standard & Poor's BBB rating.

(1) You must use the monthly average BBB rate that Standard & Poor's publishes for the first month for which the allowance is applicable.

(2) You must re-determine the rate at the beginning of each subsequent calendar year.

(e) ONRR may direct you to modify your processing allowance if:

(1) * * *

(2) ONRR determines that the consideration that you or your affiliate paid under an arm's-length processing contract does not reflect the reasonable cost of the processing because you breached your duty to market the gas, residue gas, or gas plant products for the mutual benefit of yourself and the lessor; or

(3) ONRR cannot determine if you properly calculated a processing allowance under § 1206.160 or § 1206.161 for any reason, including, but not limited to, your or your affiliate's failure to provide documents that ONRR requests under 30 CFR part 1212, subpart B.

(a)

(1) If you or your affiliate incur processing costs under an arm's-length processing contract, you may claim a processing allowance for the reasonable, actual costs incurred, as more fully explained in paragraph (b) of this section, except as provided in § 1206.159(e) and subject to the limitation in § 1206.159(c)(2).

(2) You must be able to demonstrate that your or your affiliate's contract is arm's-length.

(b)

(1) If your or your affiliate's arm's-length processing contract includes more than one gas plant product, and you can determine the processing costs for each product based on the contract, then you must determine the processing costs for each gas plant product under the contract.

(2) If your or your affiliate's arm's-length processing contract includes more than one gas plant product, and you cannot determine the processing costs attributable to each product from the contract, you must propose an allocation procedure to ONRR.

(i) You may use your proposed allocation procedure until ONRR issues its determination.

(ii) You must submit all relevant data to support your proposal.

(iii) ONRR will determine the processing allowance based upon your proposal and any additional information that ONRR deems necessary.

(iv) You must submit the allocation proposal within three months of claiming the allocated deduction on Form ONRR-2014.

(3) You may not take an allowance for the costs of processing lease production that is not royalty-bearing.

(4) If your or your affiliate's payments for processing under an arm's-length contract are not based on a dollar-per-unit basis, you must convert whatever consideration that you or your affiliate paid to a dollar-value equivalent.

(c) If you have no written contract for the arm's-length processing of gas and neither you nor your affiliate perform your own processing, you must propose to ONRR a method to determine the processing allowance using the procedures in § 1206.148(a). You may use that method to determine your allowance until ONRR issues its valuation determination.

(a) This section applies if you or your affiliate do(es) not have an arm's-length processing contract, including situations where you or your affiliate provide your own processing services. You must calculate your processing allowance based on your or your affiliate's reasonable, actual costs for processing during the reporting period using the procedures prescribed in this section.

(b) Your or your affiliate's actual costs may include:

(1) Operating expenses under paragraph (e) of this section.

(2) Overhead under paragraph (f) of this section.

(3) Either:

(i) Depreciation expense and a return on undepreciated capital costs in accordance with paragraph (h)(1) of this section, or

(ii) A cost equal to the initial depreciable capital cost of the processing plant under paragraph (i) of this section. ( printed page 39786)

(iii) Once you have elected to use either method for a processing plant, you may not later elect to change to the other alternative without ONRR's approval. If ONRR accepts your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(4) The reporting period when you do not have an arm's-length processing contract is the reporting month following the production month.

(c) You may not use any cost as a deduction that duplicates all or part of any other cost that you use under this section.

(d) Allowable capital costs are those for fixed assets which are an integral part of the processing plant.

(e) Allowable operating expenses include the following:

(1) Operations supervision and engineering

(2) Operations labor

(3) Fuel

(4) Utilities

(5) Materials

(6) Ad valorem property taxes

(7) Rent

(8) Supplies

(9) Maintenance

(10) Maintenance labor

(11) Any other directly allocable and attributable operating expense that you can document

(f) Overhead directly attributable and allocable to the operation and maintenance of the processing plant is an allowable expense.

(g) State and Federal income taxes and severance taxes and other fees, including royalties, are not allowable expenses.

(h) To calculate depreciation expense and a return on undepreciated capital costs:

(1) Depreciation and a return on undepreciated capital costs are calculated from the in-service date.

(i) If you or prior owners never claimed an allowance that included depreciation expense and a return on undepreciated capital costs or a return on initial undepreciated capital costs for a fixed asset, you may propose an alternative in-service date under (h)(4) of this section.

(ii) The alternative in-service date must not extend beyond the in-service date as extended by the shorter of the useful life and the life of the reserve.

(iii) You may not select the unit-of-production method when applying an alternative in-service date.

(iv) The application of an alternative in-service date does not change the useful life or life of the reserve.

(2) You may elect to use either a straight-line depreciation method based on the useful life or on the life of the reserves that the processing plant services or you may elect to use a unit-of-production method except when the alternative in-service date is applied under paragraph (h)(1)(i) of this section.

(i) Depreciation expense using the straight-line depreciation method is the rate of depreciation from the in-service date through the end of the useful life or life of the reserves under the first-of-month convention.

(ii) Depreciation expense using the units-of-production depreciation method is the product of the rate of depreciation and the units of output produced in the reporting period.

(iii) You may choose to apply these depreciation methods individually to each fixed asset or group of fixed assets.

(iv) After you make an election, you may not change methods without ONRR's approval. If ONRR approves your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(3) Lessees may include allowable depreciation expense for acquired fixed assets as part of a processing allowance. If you have a depreciation schedule that the original processor/lessee established in compliance with 30 CFR part 1206 for purposes of the allowance calculation, a change in ownership of a processing system will not alter the depreciation schedule that the original processor/lessee established for purposes of the allowance calculation.

(4) Proposing a depreciation schedule to ONRR:

(i) If no depreciation schedule under 30 CFR part 1206 exists or has existed for an in-service fixed asset, you may propose to ONRR a depreciation schedule for your processing allowance.

(ii) If the depreciation schedule for an in-service fixed asset does not comply with 30 CFR part 1206, you may propose to ONRR a depreciation schedule for your processing allowance.

(iii) ONRR will consider the following factors when reviewing a proposed depreciation schedule for approval:

(A) The lessee's or a prior owner's published capitalization policy, depreciation policy, fixed asset useful life policy, and any related policies in effect during the applicable period, when provided by the proposing lessee;

(B) Consistency with audited financial statements that have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), when supporting records and reconciliations are provided by the proposing lessee;

(C) Documents prepared in support of the recording and capitalization of fixed assets under U.S. GAAP, when provided by the proposing lessee;

(D) Purchase price allocation reports prepared in accordance with U.S. GAAP by independent experts, when provided by the proposing lessee;

(E) Practices typical of the industry; and

(F) Any information that ONRR deems relevant regarding the depreciation schedule.

(iv) You may use your proposed depreciation schedule to calculate a transportation allowance beginning with the production month following the month when ONRR received your proposal until ONRR accepts or rejects it. If ONRR rejects your proposed depreciation schedule, you must amend your Form ONRR-2014 for the months that you used the rejected method and pay any additional royalty due, plus late payment interest.

(5) You may depreciate a processing plant only once with or without a change in ownership.

(6) To calculate a return on undepreciated capital cost, you may use an amount equal to the undepreciated capital cost of the processing plant at the beginning of the reporting period multiplied by the rate of return that you determine under paragraph (j) of this section.

(i) After you have depreciated a processing plant to its reasonable salvage value, you may thereafter include in the allowance calculation a cost equal to the reasonable salvage value multiplied by a rate of return under paragraph (j) of this section.

(ii) You may use as a cost an amount equal to the allowable initial cost of the processing plant multiplied by the rate of return determined under paragraph (j) of this section. You may not include depreciation in your allowance.

(j) The rate of return is the industrial rate associated with Standard & Poor's BBB rating.

(1) You must use the monthly average BBB rate that Standard & Poor's publishes for the first month for which the allowance is applicable.

(2) You must re-determine the rate at the beginning of each subsequent calendar year.

(k)

(1) You must determine the processing allowance for each gas plant product based on your or your affiliate's reasonable and actual cost of processing the gas. You must base your allocation of costs to each gas plant product upon ( printed page 39787) generally accepted accounting principles.

(2) You may not take an allowance for processing lease production that is not royalty-bearing.

(l) You may apply for an exception from the requirement to calculate actual costs under paragraphs (a) and (b) of this section.

(1) ONRR will grant the exception if:

(i) You have or your affiliate has arm's-length contracts for processing other gas production at the same processing plant; and

(ii) At least 50 percent of the gas processed annually at the plant is processed under arm's-length processing contracts.

(2) If ONRR grants the exception, you must use as your processing allowance the volume-weighted average prices charged to other persons under arm's-length contracts for processing at the same plant.

The definitions in § 1206.20 do not apply to this subpart. For purposes of this subpart:

Actual cost means a cost incurred by a lessee. Actual costs do not include imputed costs, theoretical costs, or avoided costs.

Ad valorem lease means a lease where the royalty due to the lessor is based upon a percentage of the amount or value of the coal.

Allowance means a deduction used in determining value for royalty purposes. Coal washing allowance means an allowance for the reasonable, actual costs incurred by the lessee for coal washing. Transportation allowance means an allowance for the reasonable, actual costs incurred by the lessee for moving coal to a point of sale or point of delivery remote from both the lease and mine or wash plant.

Alternative in-service date means the date selected under § 1206.112(i)(1)(i) for Federal oil, § 1206.154(i)(1)(i) or § 1206.161(h)(1)(i) for Federal gas, or § 1206.259(b)(2)(v)(B)(1) or § 1206.262(b)(2)(v)(B)(1) for Federal coal. The term “alternative in-service date” has no meaning outside of the commodities and regulations mentioned.

Area means a geographic region in which coal has similar quality and economic characteristics. Area boundaries are not officially designated and the areas are not necessarily named.

Arm's-length contract means:

(1) A contract or agreement that has been arrived at in the marketplace between independent, nonaffiliated persons with opposing economic interests regarding that contract. For purposes of this subpart, two persons are affiliated if one person controls, is controlled by, or is under common control with another person. For purposes of this subpart, based on the instruments of ownership of the voting securities of an entity, or based on other forms of ownership:

(i) Ownership in excess of 50 percent constitutes control;

(ii) Ownership of 10 through 50 percent creates a presumption of control; and

(iii) Ownership of less than 10 percent creates a presumption of noncontrol which ONRR may rebut if it demonstrates actual or legal control, including the existence of interlocking directorates.

(2) Notwithstanding any other provisions of this subpart, contracts between relatives, either by blood or by marriage, are not arm's-length contracts. The ONRR may require the lessee to certify ownership control. To be considered arm's-length for any production month, a contract must meet the requirements of this definition for that production month as well as when the contract was executed.

Audit means a review, conducted in accordance with generally accepted accounting and auditing standards, of royalty payment compliance activities of lessees or other interest holders who pay royalties, rents, or bonuses on Federal leases.

BLM means the Bureau of Land Management of the Department of the Interior.

Capital cost means the actual cost associated with the initial purchase of a fixed asset with a useful life greater than one year. Non-routine, major overhauls, repairs, maintenance, or upgrades of fixed assets that extend the useful life of the asset or increase its functionality are also capital costs when their economic benefits extend beyond one year. Capital costs include those costs reasonable and necessary to bring the fixed asset to the condition and location of its intended use, such as shipping, delivery, and installation cost. The capital cost of a fixed asset reflects its value when measured at the in-service date.

Coal means coal of all ranks from lignite through anthracite.

Coal washing means any treatment to remove impurities from coal. Coal washing may include, but is not limited to, operations such as flotation, air, water, or heavy media separation; drying; and related handling (or combination thereof).

Contract means any oral or written agreement, including amendments or revisions thereto, between two or more persons and enforceable by law that with due consideration creates an obligation.

Depreciation means the systematic and rational allocation of the capital cost less a reasonable salvage value of a fixed asset to expense during periods when economic benefits are available to obtain from the fixed asset. Depreciation begins at the in-service date.

Depreciation schedule means a document used to record and track depreciation for a fixed asset under 30 CFR part 1206. A depreciation schedule includes a list of fixed assets that can be separately identified. Each fixed asset entry must include the capital cost, the in-service date, the method of depreciation elected, the salvage value, and either the useful life, units of production, or life of reserve. For fixed assets depreciated as a group, the depreciation schedule demonstrates, or allows for the calculation of, either the group's useful life, units of production, or life of the reserve. The depreciation schedule includes, or allows for the calculation of, depreciation expense during the reporting period and the undepreciated capital cost.

First-of-month convention means that depreciation begins on the first day of the month of the in-service date or alternative in-service date.

Fixed assets means tangible assets owned or controlled by a lessee that are used to produce or provide goods and services in the primary business activities of that entity. Fixed assets have a useful life greater than one year.

Gross proceeds (for royalty payment purposes) means the total monies and other consideration accruing to a coal lessee for the production and disposition of the coal produced. Gross proceeds includes, but is not limited to, payments to the lessee for certain services such as crushing, sizing, screening, storing, mixing, loading, treatment with substances including chemicals or oils, and other preparation of the coal to the extent that the lessee is obligated to perform them at no cost to the Federal Government. Gross proceeds, as applied to coal, also includes but is not limited to reimbursements for royalties, taxes or fees, and other reimbursements. Tax reimbursements are part of the gross proceeds accruing to a lessee even though the Federal royalty interest may be exempt from taxation. Monies and other consideration, including the forms of consideration identified in this paragraph, to which a lessee is contractually or legally entitled but which it does not seek to collect through ( printed page 39788) reasonable efforts are also part of gross proceeds.

In-service date means the earlier of the date when a fixed asset is placed in service or the date when a fixed asset is functionally ready and available for its intended use. When considering a group of fixed assets, the group in-service date is the in-service date for the primary functional fixed asset of the group.

Life of the reserve means the estimated term over which the natural reserve provides an economic benefit. A life of the reserve estimate is based on a report from an unaffiliated or independent expert and clearly identify the assumptions supporting the estimate. If a fixed asset services multiple reserves, the life of the reserve represents the average of the individual reserve life estimates. Life of the reserve is measured in, or is convertible into, months and is determined at or prior to the in-service date.

Lease means any contract, profit-share arrangement, joint venture, or other agreement issued or approved by the United States for a Federal coal resource under a mineral leasing law that authorizes exploration for, development or extraction of, or removal of coal—or the land covered by that authorization, whichever is required by the context.

Lessee means any person to whom the United States issues a lease, and any person who has been assigned an obligation to make royalty or other payments required by the lease. This includes any person who has an interest in a lease as well as an operator or payor who has no interest in the lease but who has assumed the royalty payment responsibility.

Like-quality coal means coal that has similar chemical and physical characteristics.

Marketable condition means coal that is sufficiently free from impurities and otherwise in a condition that it will be accepted by a purchaser under a sales contract typical for that area.

Mine means an underground or surface excavation or series of excavations and the surface or underground support facilities that contribute directly or indirectly to mining, production, preparation, and handling of lease products.

Net-back method means a method for calculating market value of coal at the lease or mine. Under this method, costs of transportation, washing, handling, etc., are deducted from the ultimate proceeds received for the coal at the first point at which reasonable values for the coal may be determined by a sale pursuant to an arm's-length contract or by comparison to other sales of coal, to ascertain value at the mine.

Net output means the quantity of washed coal that a washing plant produces.

Netting is the deduction of an allowance from the sales value by reporting a one line net sales value, instead of correctly reporting the deduction as a separate line item on the Form ONRR-4430.

Operating Expense means costs associated with the production or provision of goods and services by a business. Operating expenses are costs necessary for the company's normal, core business activities.

Overhead means the indirect costs of producing or providing goods and services. Overhead must be systematically and rationally allocated to the goods or services being produced or provided. Overhead is a cost necessary for the company's normal, core business activities.

Person means by individual, firm, corporation, association, partnership, consortium, or joint venture.

Reserve means the estimated quantity of known accumulations of a natural resource anticipated to be commercially recoverable from a defined area under existing economic conditions and by established operating practices from a given date forward.

Sales type code means the contract type or general disposition ( e.g., arm's-length or non-arm's-length) of production from the lease. The sales type code applies to the sales contract, or other disposition, and not to the arm's-length or non-arm's-length nature of a transportation or washing allowance.

Salvage value means the value net of disposal costs that the payor expects to realize at the end of the useful life of an asset. Salvage values are designed to minimize any gain or loss at the time of disposal. Salvage value is greater than or equal to zero. Salvage value is determined at or prior to the in-service date.

Spot market price means the price received under any sales transaction when planned or actual deliveries span a short period of time, usually not exceeding one year.

Straight-line depreciation method means a method of depreciation that allocates capital costs evenly over the useful life of an asset or the life of the reserve. The rate of depreciation applicable to the reporting period under this method is determined by dividing the capital cost by the useful life of the fixed asset or the life of the reserve.

Unit-of-production depreciation method means a method of depreciation that allocates capital cost based on the fixed asset's designed specifications and output parameters. The rate of depreciation applicable to the reporting period under this method is determined by dividing the capital cost by the units of production for which the fixed asset was designed.

Units of production means the machine-hours for which an asset was designed to operate or the units of output that an asset was designed to produce. The units of production for a group of fixed assets are the capital-cost-weighted average units of production of the fixed assets comprising the group. Units of production are determined at or prior to the in-service date.

Useful life means the term over which the asset provides an economic benefit. If a useful life is applied to a group of fixed assets, it represents the capital-cost-weighted average useful life of the fixed assets comprising the group. Useful life is measured in, or is convertible into, months and is determined at or prior to the in-service date.

(a) Arm's-length contracts.

(1) For washing costs incurred by a lessee under an arm's-length contract, the washing allowance shall be the reasonable actual costs incurred by the lessee for washing the coal under that contract, subject to monitoring, review, audit, and possible future adjustment. The lessee shall have the burden of demonstrating that its contract is arm's-length. ONRR's prior approval is not required before a lessee may deduct costs incurred under an arm's-length contract. The lessee must claim a washing allowance by reporting it as a separate line entry on the Form ONRR-4430.

(2) In conducting reviews and audits, ONRR will examine whether the contract reflects more than the consideration actually transferred either directly or indirectly from the lessee to the washer for the washing. If the contract reflects more than the total consideration paid, then the ONRR may require that the washing allowance be determined in accordance with paragraph (b) of this section.

(3) If ONRR determines that the consideration paid pursuant to an arm's-length washing contract does not reflect the reasonable value of the washing because of misconduct by or between the contracting parties, or because the lessee otherwise has breached its duty to the lessor to market the production for the mutual benefit of the lessee and the lessor, then ONRR shall require that ( printed page 39789) the washing allowance be determined in accordance with paragraph (b) of this section. When ONRR determines that the value of the washing may be unreasonable, ONRR will notify the lessee and give the lessee an opportunity to provide written information justifying the lessee's washing costs.

(4) Where the lessee's payments for washing under an arm's-length contract are not based on a dollar-per-unit basis, the lessee shall convert whatever consideration is paid to a dollar value equivalent. Washing allowances shall be expressed as a cost per ton of coal washed.

(b) Non-arm's-length or no contract.

(1) If a lessee has a non-arm's-length contract or has no contract, including those situations where the lessee performs washing for itself, the washing allowance will be based upon the lessee's reasonable actual costs. All washing allowances deducted under a non-arm's-length or no contract situation are subject to monitoring, review, audit, and possible future adjustment. The lessee must claim a washing allowance by reporting it as a separate line entry on the Form ONRR-4430. When necessary or appropriate, ONRR may direct a lessee to modify its estimated or actual washing allowance.

(i) The reporting period when you do not have an arm's-length washing contract is the reporting month following the production month.

(ii) You may not use any cost as a deduction that duplicates all or part of any other cost that you use under this section.

(2) The washing allowance for non-arm's-length or no contract situations shall be based upon the lessee's actual costs for washing during the reported period, including operating expenses, overhead, and either depreciation expense and a return on undepreciated capital costs in accordance with paragraph (b)(2)(v) of this section, or a cost equal to the initial capital cost of the wash plant multiplied by the rate of return in accordance with paragraph (b)(2)(vi) of this section. Allowable capital costs are those for fixed assets which are an integral part of the wash plant.

(i) Allowable operating expenses include: operations supervision and engineering; operations labor; fuel; utilities; materials; ad valorem property taxes; rent; supplies; maintenance; maintenance labor; and any other directly allocable and attributable operating expense which the lessee can document.

(ii) Overhead attributable and allocable to the operation and maintenance of the wash plant is an allowable expense.

(iii) State and Federal income taxes and severance taxes, including royalties, are not allowable expenses.

(iv) A lessee may use either paragraph (b)(2)(v) or (b)(2)(vi) of this section. After a lessee has elected to use either method for a wash plant, the lessee may not later elect to change to the other alternative without approval of the ONRR.

(v) To compute depreciation expense:

(A) The lessee may elect to use either a straight-line depreciation method based on the useful life of equipment or on the life of the reserves which the wash plant services, whichever is appropriate, or a unit-of-production method.

(1) Depreciation expense using the straight-line depreciation method is the rate of depreciation from the in-service date through the end of the useful life or life of the reserves under the first-of-month convention.

(2) Depreciation expense using the units-of-production depreciation method is the product of the rate of depreciation and the units of output produced in the reporting period.

(3) You may choose to apply these depreciation methods individually to each fixed asset or group of fixed assets.

(4) After you make an election, you may not change methods without ONRR's approval. If ONRR approves your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(B) Depreciation and a return on undepreciated capital costs are calculated from the in-service date.

(1) If you or prior owners never claimed an allowance that included depreciation expense and a return from undepreciated capital costs or a return on initial undepreciated capital costs for a fixed asset, you may propose an alternative in-service date under (b)(2)(v)(D).

(2) The alternative in-service date must not extend beyond the in-service date as extended by the shorter of the useful life and the life of the reserve.

(3) You may not select the unit-of-production method when applying an alternative in-service date.

(4) The application of an alternative in-service date does not change the useful life or life of the reserve.

(C) Lessees may include allowable depreciation expense for acquired fixed assets as part of a washing allowance. If you have a depreciation schedule that the original lessee established in compliance with 30 CFR part 1206 for purposes of the allowance calculation, a change in ownership of a washing system will not alter that depreciation schedule.

(D) Proposing a depreciation schedule to ONRR:

(1) If no depreciation schedule under 30 CFR part 1206 exists or has existed for an in-service fixed asset, you may propose to ONRR a depreciation schedule for your washing allowance.

(2) If the depreciation schedule for an in-service fixed asset does not comply with 30 CFR part 1206, you may propose to ONRR a depreciation schedule for your washing allowance.

(3) ONRR will consider the following factors when reviewing a proposed depreciation schedule for approval: the lessee's or a prior owner's published capitalization policy, depreciation policy, fixed asset useful life policy, and any related polices in effect during the applicable period, when provided by the proposing lessee; consistency with audited financial statements that have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), when supporting records and reconciliations are provided by the proposing lessee; documents prepared in support of the recording and capitalization of fixed assets under U.S. GAAP, when provided by the proposing lessee; purchase price allocation reports prepared in accordance with U.S. GAAP by independent experts, when provided by the proposing lessee; practices typical of the industry; and any information that ONRR deems relevant regarding the depreciation schedule.

(E) With or without a change in ownership, a wash plant is depreciated only once. Equipment will not be depreciated below a reasonable salvage value.

(F) To calculate the return on undepreciated capital cost, you may use an amount equal to the undepreciated capital cost at the beginning of the reporting period of the washing system multiplied by the rate of return that you determine under paragraph (b)(2)(vii) of this section.

(G) After you have depreciated a washing system to the reasonable salvage value, you may thereafter include in the allowance calculation a cost equal to the reasonable salvage value multiplied by a rate of return under paragraph (v) of this section.

(vi) ONRR shall allow as a cost an amount equal to the allowable initial capital cost of the wash plant multiplied by the rate of return determined pursuant to paragraph (b)(2)(vii) of this section. No allowance shall be provided for depreciation. This alternative shall ( printed page 39790) apply only to plants first placed in service or acquired after March 1, 1989.

(vii) The rate of return must be the industrial rate associated with Standard and Poor's BBB rating. The rate of return must be the monthly average rate as published in Standard and Poor's Bond Guide for the first month for which the allowance is applicable. The rate must be redetermined at the beginning of each subsequent calendar year.

(viii) The washing allowance for coal shall be determined based on the lessee's reasonable and actual cost of washing the coal. The lessee may not take an allowance for the costs of washing lease production that is not royalty bearing.

(c) Reporting requirements —

(1) Arm's-length contracts.

(i) The lessee must notify ONRR of an allowance based on incurred costs by using a separate line entry on the Form ONRR-4430.

(ii) ONRR may require that a lessee submit arm's-length washing contracts and related documents. Documents shall be submitted within a reasonable time, as determined by ONRR.

(2) Non-arm's-length or no contract.

(i) The lessee must notify ONRR of an allowance based on the incurred costs by using a separate line entry on the Form ONRR-4430.

(ii) For new washing facilities or arrangements, the lessee's initial washing deduction shall include estimates of the allowable coal washing costs for the applicable period. Cost estimates shall be based upon the most recently available operations data for the washing system or, if such data are not available, the lessee shall use estimates based upon industry data for similar washing systems.

(iii) Upon request by ONRR, the lessee shall submit all data used to prepare the allowance deduction. The data shall be provided within a reasonable period of time, as determined by ONRR.

(d) Interest and assessments.

(1) If a lessee nets a washing allowance on the Form ONRR-4430, then the lessee shall be assessed an amount up to 10 percent of the allowance netted not to exceed $250 per lease sales type code per sales period.

(2) If a lessee erroneously reports a washing allowance which results in an underpayment of royalties, interest shall be paid on the amount of that underpayment.

(3) Interest required to be paid by this section shall be determined in accordance with § 1218.202 of this subchapter.

(e) Adjustments.

(1) If the actual coal washing allowance is less than the amount the lessee has taken on Form ONRR-4430 for each month during the allowance reporting period, the lessee shall pay additional royalties due plus interest computed under § 1218.202 of this subchapter from the date when the lessee took the deduction to the date the lessee repays the difference to ONRR. If the actual washing allowance is greater than the amount the lessee has taken on Form ONRR-4430 for each month during the allowance reporting period, the lessee shall be entitled to a credit without interest.

(2) The lessee must submit a corrected Form ONRR-4430 to reflect actual costs, together with any payment, in accordance with instructions provided by ONRR.

(f) Other washing cost determinations. The provisions of this section shall apply to determine washing costs when establishing value using a net-back valuation procedure or any other procedure that requires deduction of washing costs.

(a) Arm's-length contracts.

(1) For transportation costs incurred by a lessee pursuant to an arm's-length contract, the transportation allowance shall be the reasonable, actual costs incurred by the lessee for transporting the coal under that contract, subject to monitoring, review, audit, and possible future adjustment. The lessee shall have the burden of demonstrating that its contract is arm's-length. The lessee must claim a transportation allowance by reporting it as a separate line entry on the Form ONRR-4430.

(2) In conducting reviews and audits, ONRR will examine whether the contract reflects more than the consideration actually transferred either directly or indirectly from the lessee to the transporter for the transportation. If the contract reflects more than the total consideration paid, then the ONRR may require that the transportation allowance be determined in accordance with paragraph (b) of this section.

(3) If ONRR determines that the consideration paid pursuant to an arm's-length transportation contract does not reflect the reasonable value of the transportation because of misconduct by or between the contracting parties, or because the lessee otherwise has breached its duty to the lessor to market the production for the mutual benefit of the lessee and the lessor, then ONRR shall require that the transportation allowance be determined in accordance with paragraph (b) of this section. When ONRR determines that the value of the transportation may be unreasonable, ONRR will notify the lessee and give the lessee an opportunity to provide written information justifying the lessee's transportation costs.

(4) Where the lessee's payments for transportation under an arm's-length contract are not based on a dollar-per-unit basis, the lessee shall convert whatever consideration is paid to a dollar value equivalent for the purposes of this section.

(b) Non-arm's-length or no contract.

(1) If a lessee has a non-arm's-length contract or has no contract, including those situations where the lessee performs transportation services for itself, the transportation allowance will be based upon the lessee's reasonable actual costs. All transportation allowances deducted under a non-arm's-length or no contract situation are subject to monitoring, review, audit, and possible future adjustment. The lessee must claim a transportation allowance by reporting it as a separate line entry on the Form ONRR-4430. When necessary or appropriate, ONRR may direct a lessee to modify its estimated or actual transportation allowance deduction.

(i) The reporting period when you do not have an arm's-length transportation contract is the reporting month following the production month.

(ii) You may not use any cost as a deduction that duplicates all or part of any other cost that you use under this section.

(2) The transportation allowance for non-arm's-length or no-contract situations shall be based upon the lessee's actual costs for transportation during the reporting period, including operating expenses, overhead, and either depreciation expense and a return on undepreciated capital costs in accordance with paragraph (b)(2)(v) of this section, or a cost equal to the initial capital costs of the transportation system multiplied by the rate of return in accordance with paragraph (b)(2)(vi) of this section. Allowable capital costs are those for fixed assets which are an integral part of the transportation system.

(i) Allowable operating expenses include: operations supervision and engineering; operations labor; fuel; utilities; materials; ad valorem property taxes; rent; supplies; maintenance; maintenance labor; and any other directly allocable and attributable operating expense which the lessee can document.

(ii) Overhead attributable and allocable to the operation and ( printed page 39791) maintenance of the transportation system is an allowable expense.

(iii) State and Federal income taxes and severance taxes and other fees, including royalties, are not allowable expenses.

(iv) A lessee may use either paragraph (b)(2)(v) or (b)(2)(vi) of this section. After a lessee has elected to use either method for a transportation system, the lessee may not later elect to change to the other alternative without approval of ONRR.

(v) To compute depreciation expense:

(A) The lessee may elect to use either a straight-line depreciation method based on the useful life of equipment or on the life of the reserves which the transportation system services, whichever is appropriate, or a unit of production method.

(1) Depreciation expense using the straight-line depreciation method is the rate of depreciation from the in-service date through the end of the useful life or life of the reserves under the first-of-month convention.

(2) Depreciation expense using the units-of-production depreciation method is the product of the rate of depreciation and the units of output produced in the reporting period.

(3) You may choose to apply these depreciation methods individually to each fixed asset or group of fixed assets.

(4) After you make an election, you may not change methods without ONRR's approval. If ONRR accepts your request to change methods, you may use your changed method beginning with the production month following the month when ONRR received your change request.

(B) Depreciation and a return on undepreciated capital costs are calculated from the in-service date.

(1) If you or prior owners never claimed an allowance that included depreciation expense and a return from undepreciated capital costs or a return on initial undepreciated capital costs for a fixed asset, you may propose an alternative in-service date under (b)(2)(v)(D) of this section.

(2) The alternative in-service date must not extend beyond the in-service date as extended by the shorter of the useful life and the life of the reserve.

(3) You may not select the unit-of-production method when applying an alternative in-service date.

(4) The application of an alternative in-service date does not change the useful life or life of the reserve.

(C) Lessees may include allowable depreciation expense for acquired fixed assets as part of a washing allowance. If you have a depreciation schedule that the original lessee established in compliance with 30 CFR part 1206 for purposes of the allowance calculation, a change in ownership of a transportation system will not alter that depreciation schedule.

(D) Proposing a depreciation schedule to ONRR:

(1) If no depreciation schedule under 30 CFR part 1206 exists or has existed for an in-service fixed asset, you may propose to ONRR a depreciation schedule for your transportation allowance.

(2) If the depreciation schedule for an in-service fixed asset does not comply with 30 CFR part 1206, you may propose to ONRR a depreciation schedule for your washing allowance.

(3) ONRR will consider the following factors when reviewing a proposed depreciation schedule for approval: the lessee's or a prior owner's published capitalization policy, depreciation policy, fixed asset useful life policy, and any related polices in effect during the applicable period, when provided by the proposing lessee; consistency with audited financial statements that have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), when supporting records and reconciliations are provided by the proposing lessee; documents prepared in support of the recording and capitalization of fixed assets under U.S. GAAP, when provided by the proposing lessee; purchase price allocation reports prepared in accordance with U.S. GAAP by independent experts, when provided by the proposing lessee; practices typical of the industry; and any information that ONRR deems relevant regarding the depreciation schedule.

(E) With or without a change in ownership, a transportation system shall be depreciated only once. Equipment shall not be depreciated below a reasonable salvage value.

(F) To calculate the return on undepreciated capital cost, you may use an amount equal to the undepreciated capital cost at the beginning of the reporting period of the transportation system multiplied by the rate of return that you determine under paragraph (b)(2)(vii) of this section.

(G) After you have depreciated a transportation system to the reasonable salvage value, you may thereafter include in the allowance calculation a cost equal to the reasonable salvage value multiplied by a rate of return under paragraph (v) of this section.

(vi) ONRR shall allow as a cost an amount equal to the allowable initial capital cost of the transportation system multiplied by the rate of return determined pursuant to paragraph (b)(2)(vii) of this section. No allowance shall be provided for depreciation. This alternative shall apply only to transportation facilities first placed in service or acquired after March 1, 1989.

(vii) The rate of return must be the industrial rate associated with Standard and Poor's BBB rating. The rate of return must be the monthly average rate as published in Standard and Poor's Bond Guide for the first month for which the allowance is applicable. The rate must be redetermined at the beginning of each subsequent calendar year.

(3) A lessee may apply to ONRR for exception from the requirement that it compute actual costs in accordance with paragraphs (b)(1) and (2) of this section. ONRR will grant the exception only if the lessee has a rate for the transportation approved by a Federal agency or by a State regulatory agency (for Federal leases). ONRR shall deny the exception request if it determines that the rate is excessive as compared to arm's-length transportation charges by systems, owned by the lessee or others, providing similar transportation services in that area. If there are no arm's-length transportation charges, ONRR shall deny the exception request if:

(i) No Federal or State regulatory agency costs analysis exists and the Federal or State regulatory agency, as applicable, has declined to investigate under ONRR timely objections upon filing; and

(ii) The rate significantly exceeds the lessee's actual costs for transportation as determined under this section.

(c) Reporting requirements —

(1) Arm's-length contracts.

(i) The lessee must notify ONRR of an allowance based on incurred costs by using a separate line entry on the form ONRR-4430.

(ii) ONRR may require that a lessee submit arm's-length transportation contracts, production agreements, operating agreements, and related documents. Documents shall be submitted within a reasonable time, as determined by ONRR.

(2) Non-arm's-length or no contract.

(i) The lessee must notify ONRR of an allowance based on the incurred costs by using a separate line entry on Form ONRR-4430.

(ii) For new transportation facilities or arrangements, the lessee's initial deduction shall include estimates of the allowable coal transportation costs for the applicable period. Cost estimates shall be based upon the most recently available operations data for the transportation system or, if such data are not available, the lessee shall use ( printed page 39792) estimates based upon industry data for similar transportation systems.

(iii) Upon request by ONRR, the lessee shall submit all data used to prepare the allowance deduction. The data shall be provided within a reasonable period of time, as determined by ONRR.

(iv) If the lessee is authorized to use its Federal- or State-agency-approved rate as its transportation cost in accordance with paragraph (b)(3) of this section, it shall follow the reporting requirements of paragraph (c)(1) of this section.

(d) Interest and assessments.

(1) If a lessee nets a transportation allowance on Form ONRR-4430, the lessee shall be assessed an amount of up to 10 percent of the allowance netted not to exceed $250 per lease sales type code per sales period.

(2) If a lessee erroneously reports a transportation allowance which results in an underpayment of royalties, interest shall be paid on the amount of that underpayment.

(3) Interest required to be paid by this section shall be determined in accordance with § 1218.202 of this subchapter.

(e) Adjustments.

(1) If the actual coal transportation allowance is less than the amount the lessee has taken on Form ONRR-4430 for each month during the allowance reporting period, the lessee shall pay additional royalties due plus interest computed under § 1218.202 of this subchapter from the date when the lessee took the deduction to the date the lessee repays the difference to ONRR. If the actual transportation allowance is greater than amount the lessee has taken on Form ONRR-4430 for each month during the allowance reporting period, the lessee shall be entitled to a credit without interest.

(2) The lessee must submit a corrected Form ONRR-4430 to reflect actual costs, together with any payments, in accordance with instructions provided by ONRR.

(f) Other transportation cost determinations. The provisions of this section shall apply to determine transportation costs when establishing value using a net-back valuation procedure or any other procedure that requires deduction of transportation costs.

(f) The ONRR Director will review the record that was before the ONRR issuing office along with the written statement of reasons submitted by the appellant and render a decision in the case. The ONRR Director will determine if there is credible evidence to support the Order and shall review all conclusions of law de novo. Such decision will be made in a timely manner and not unreasonably withheld.