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Marathon loses Alaska Supreme Court case DNR upheld on decision to partially deny company’s request to use different royalty calculation method for Ninilchik gas production Wesley Loy For Petroleum News
Marathon Oil has lost a court battle with the state over royalty payments on natural gas produced from an Alaska field.
In a 17-page opinion issued June 10, the Alaska Supreme Court affirmed a state Superior Court ruling that went against Marathon.
The case has to do with royalty payments on production from the Ninilchik gas field on the southern Kenai Peninsula. Marathon began production from the field in 2003.
Marathon sued the Alaska Department of Natural Resources in 2008 after state officials partially refused the company’s request to change the method of calculating royalty payments owed on its Ninilchik gas production.
Calculating royalties The Supreme Court opinion does not specify the amount of money at stake for Marathon in its royalty dispute with the state.
Under the Alaska Land Act of 1959, the year Alaska became a state, DNR is required to collect a royalty of at least 12.5 percent of the value of oil and gas produced on land leased from the state.
According to the most recent state Division of Oil and Gas annual report (2009), Marathon’s Ninilchik unit had royalty gas production of 8.03 billion cubic feet from 2003 through 2008, and royalty gas revenues of $35.5 million.
State records show Marathon holds a 60 percent interest in the Ninilchik unit, with Union Oil Co. of California holding the remaining 40 percent.
The Supreme Court opinion explains that gas producers on state land must make royalty payments calculated using either “higher of” pricing or contract pricing.
Determining the value of gas to calculate royalties usually is done through “higher of” pricing, the opinion says. The value of the gas is deemed to be the highest of four possible prices, and arriving at the result “involves sophisticated calculations using market data and the prices of other producers.”
Lessees must pay royalties on or before the last day of the calendar month following the month in which the gas is produced.
“But the four values needed to calculate the royalty under ‘higher of’ pricing are usually not determined until several years after the time of production, after DNR performs an audit,” the Supreme Court opinion says.
The audit often results in an upward adjustment of a lessee’s royalty liability, the opinion says.
Marathon’s request Producers may pay royalties using the “potentially more favorable” contract pricing method, but they must receive permission from DNR, the opinion says.
Under contract pricing, the price at which a producer sells gas to Alaska utilities is the basis for calculating the state’s royalty.
“In 2008, before completion of the audit to determine the ‘higher of’ royalty payment for 2003-2008, Marathon requested contract pricing from DNR,” the opinion says. “Marathon requested contract pricing for the period of 2008 onward and sought retroactive application of contract pricing to the 2003-2008 period. DNR approved Marathon’s request for contract pricing from 2008 onward but denied the request to apply contract pricing to production prior to 2008.”
Marathon appealed to the Superior Court, which upheld DNR’s ruling.
The company then appealed to the Supreme Court, making three arguments: DNR was wrong to deny the request to apply contract pricing retroactively; DNR should have put its policy into regulation; and DNR’s treatment of Marathon violated due process.
“The question presented is whether a lessee must apply for contract pricing before production actually occurs,” the Supreme Court opinion says.
The court conceded the statute on this is ambiguous.
But the court held against Marathon and in favor of the state on all points, writing in part that Marathon’s due-process rights were not violated and that DNR has reasonably applied its policy against retroactive contract pricing for at least a decade.
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