• Could the U.S. Government's Recouping of Offshore Oil & Gas Royalties be Considered an Illegal Taking?
  • October 31, 2008
  • Law Firm: Beirne, Maynard & Parsons, L.L.P. - Houston Office
  • In October of 2007, the U.S. District Court for the Western District of Louisiana issued an opinion that could conceivably impact upcoming legislation. The Court, in Kerr-McGee Oil & Gas Corp. v. Allred, held that the U.S. government could not collect royalties from offshore oil and gas leases for production that was below the statutorily set minimum volume of royalty-free production, even though the average annual price was in excess of the price-thresholds contained in the leases. In other words, the Court held that the oil companies should not have to pay millions of dollars in royalties before they even produced the minimum volume of royalty-free production.

    Congress originally passed the Deep Water Royalty Relief Act in 1995 to give the oil and gas companies a respite from royalty payments for leases sold between 1996 and 2000. The Act provided that companies would not have to pay royalties on production under a certain minimum volume. It was hoped that this would provide incentive for the companies to drill for oil on the outer-continental shelf in the Gulf of Mexico. The oil and gas leases, however, also contain language that allows the government to receive royalty payments when market prices reach a certain level or “price-threshold.”

    The royalties system has been plagued by controversy since its inception:

    • In the mid-1990s, a dozen major oil companies were sued for intentionally misreporting their sale prices for oil in order to pay lower royalties. They settled for approximately $438 million.
    • More sweeping allegations were made in the 2000s of natural gas royalty underpayments by the entire industry.
    • The royalty price-threshold language was accidentally omitted from over 1,000 leases sold in 1998 and 1999, and the Department of the Interior (“DOI”) spent years trying to fix the error.
    • Criminal investigations were undertaken against DOI employees who managed the royalties-in-kind program. The employees were allegedly paid as consultants for oil companies.

    Now, Kerr-McGee (purchased by Anadarko in 2006) has brought suit claiming the DOI could not recoup royalties on eight different leases for the production that was below the minimum volume of royalty-free production. The Court granted Kerr-McGee’s Motion for Summary Judgment, holding that the DOI had exceeded its Congressional authority by imposing a price-threshold that would require Kerr-McGee to pay millions of dollars in royalties before it had even produced the minimum volume of royalty-free production.

    The ruling in the Kerr-McGee case is now being cited as ammunition in the fight against proposed legislation that may directly or indirectly impose price-thresholds on oil and gas leases. Attorneys for leaseholders are threatening a multi-billion dollar lawsuit if legislation is passed that will charge a per barrel (or per million BTU) fee when a certain price-threshold is surpassed (i.e., $34.73 per barrel, and $4.34 per million BTU). Leaseholders claim that the legislative imposition of such price-thresholds, and the resulting royalty payments, would constitute a “taking” without just compensation in violation of the 5th Amendment.

    Whether this Court decision (which will almost certainly be appealed) and these threats of legal action actually deter Congress from setting price-thresholds remains to be seen, but these events should certainly have a significant impact on the renegotiation of many major oil companies’ leases.