Recent Litigation Related to Royalties from Federal Offshore Oil and Gas Production
Recent Litigation Related to Royalties from
Federal Offshore Oil and Gas Production
Adam Vann
Legislative Attorney
American Law Division
Summary
On October 30, 2007, the U.S. District Court for the Western District of Louisiana
issued a ruling in Kerr-McGee Oil & Gas Corp. v. Allred that rebuffed efforts of the
U.S. Department of the Interior to collect royalties from offshore oil and gas production1
leases based on so-called “price thresholds” for previously granted royalty relief. There
has been considerable interest in the impact of this ruling on ongoing congressional
efforts related to certain “missing” royalty payment requirements in leases issued by the
Minerals Management Service of the U.S. Department of the Interior (MMS) in 1998
and 1999, including the proposed Royalty Relief for American Consumers Act of 2007,
as found at sections 7501-7505 of H.R. 3221. The House of Representatives passed H.R.
3221 on August 4, 2007. This report (1) provides background on the Outer Continental
Shelf Deep Water Royalty Relief Act (DWRRA), pursuant to which royalty-free leases,
including the controversial 1998 and 1999 leases, were issued; (2) summarizes relevant
portions of the proposed Royalty Relief for American Consumers Act,2 which attempts
to encourage the renegotiation of the controversial 1998 and 1999 leases; (3)
summarizes the recent ruling in the Kerr-McGee matter; and (4) analyzes the potential
impact of that recent ruling on the proposed Royalty Relief for American Consumers
Act and any similar legislative efforts.3
1 Kerr-McGee Oil & Gas Corp. v. Allred, No. 2:06-CV-0439 (W.D. La. October 30, 2007)
(memorandum ruling). The court granted the plaintiff’s motion for summary judgment in the
case on the same day that it issued the memorandum ruling.
2 H.R. 3221, Title VII, Subtitle E.
3 This analysis is restricted to a discussion of the potential impact of the recent ruling on section
It does not address section 7503 of H.R. 3221, which seeks to “clarify the authority” of the
Secretary of the Interior to include price thresholds on royalty relief in offshore leases pursuant
to section 304 of the DWRRA.
The Deep Water Royalty Relief Act and the 1998-1999 Leases
Most federal offshore oil and gas production leases contain royalty provisions that
require the lessee to pay a certain percentage of revenue on the value of oil and natural gas
production to the federal government as the lessor. In 1995, Congress passed the
DWRRA,4 which provides an incentive for exploration of oil and natural gas reserves in
“deep water,” which might otherwise be uneconomic, by providing that a certain initial
volume of production from deep water wells would be exempt from royalty obligations.
Section 302 of the DWRRA provides a mechanism by which holders of existing leases
can apply for royalty relief, which is to be granted by the Secretary of the Interior if the
lease would otherwise be uneconomic. However, Section 302 also provides that these
lessees will not be eligible for royalty relief if the price of oil or natural gas exceeds a
certain threshold level.
While Section 302 of the DWRRA addresses royalty relief for holders of leases in
existence at the time of the enactment of the act, Sections 303 and 304 address post-
enactment lease sales. Section 303 amends the bidding system to allow Interior to offer
leases going forward with royalty relief at the discretion of the Department, while Section
304 carves out an exception to that royalty payment requirement for deep water leases that
were entered into within five years of the date of enactment of the DWRRA. Pursuant to
Section 304, the standard royalty requirement is to be suspended for lessees holding these
leases until a certain volume of oil or natural gas is produced by the lessee. The
volumetric limitation on royalty relief varies based on the water depth of the leased tract.
Once the volumetric threshold is exceeded, a lessee may be required to make royalty
payments. Section 304 sets a statutory minimum for the volumetric threshold for royalty
relief — the Secretary of the Interior is authorized to grant a higher volumetric threshold
at his or her discretion.
In 1998 and 1999, MMS issued deepwater offshore leases that were eligible for
royalty suspension but did not include a price-based limitation on that eligibility. As a
result, holders of these 1998 and 1999 deepwater leases have no obligations to make
royalty payments up to the suspension volumes, regardless of the market price of oil or
natural gas; the leases do not contain a price threshold on royalty relief.
The Royalty Relief for American Consumers Act of 2007
On August 4, 2007, the House passed H.R. 3221. Included in this omnibus energy5
bill is the proposed Royalty Relief for American Consumers Act of 2007. One section
of this proposed act bars the Secretary of the Interior from issuing any new leases to
holders of “covered leases” unless said leaseholders either renegotiate their “covered
leases” to include price thresholds or pay a “conservation of resources” fee as established6
in the proposed act. The statute defines a “covered lease” as “a lease for oil or gas
production in the Gulf of Mexico that is ... issued by the Department of the Interior under
Section 304 of the Outer Continental Shelf Deep Water Royalty Relief Act ... and ... not
4 P.L. 104-58, Title III.
5 H.R. 3221, Title VII, Subtitle E.
6 Id. at section 7504.
subject to limitations on royalty relief based on market prices that are equal to or less than
the price thresholds” described in the DWRRA.7 Any holder of a “covered lease” is forced
to decide between three options: (1) the lessee can keep the lease under its current terms
(i.e., without a price threshold) and lose the right to bid on future offshore lease sales in
the Gulf of Mexico; (2) the lessee can pay a newly created “conservation of resources”
fee, as established elsewhere in the proposed act; or (3) the lessee can renegotiate the
covered lease to include royalty relief price thresholds. Many observers interpret the
proposed act as a legislative attempt to correct the perceived oversight in the 1998-1999
leases that lack price thresholds.8
Kerr-McGee Oil & Gas Corp. v. Allred
Around the same time that the perceived oversight in the 1998 and 1999 leases
described above was brought to the public’s attention, Kerr-McGee Oil & Gas Corp.9
(Kerr-McGee) initiated litigation that challenged the authority of the Department of the
Interior to impose price thresholds on leases sold between 1996 and 2000, i.e., the
effective period of section 304 of the DWRRA. According to Kerr-McGee, section 304
of the DWRRA, which addresses lease sales during the five-year period between 1996
and 2000, barred the inclusion of royalty relief price thresholds to these leases, and
therefore the collection of royalties resulting from the imposition of price thresholds10
contradicted section 304 of the DWRRA. Kerr-McGee brought its claim in the U.S.
District Court for the Western District of Louisiana after the U.S. Department of the
Interior issued an Order directing Kerr-McGee to pay royalties on oil and natural gas
produced in 2003 and 2004 under eight leases operated by Kerr-McGee under the11
DWRRA.
On October 30, 2007, the court issued a ruling that essentially confirmed Kerr-
McGee’s position and found that an Order issued by the Department of the Interior
directing Kerr-McGee to pay royalties based on a price threshold was in error. The court
based its ruling on a decision issued by the U.S. Court of Appeals for the Fifth Circuit in12
The Fifth Circuit interpreted Sections 303 and 304 of the DWRRA as they pertain to
new production requirements for Mandatory Royalty Relief leases. Section 303 added
a new bidding system that gave the Interior the authority to lease any water depth in
7 H.R. 3221, section 7504(d)(1).
8 For a discussion of some of the potential legal challenges to this legislation, see CRS Report
RL33974, Legal Issues Raised by Provision in House Energy Bill (H.R. 6) Creating Incentives
for Certain OCS Leaseholders to Accept Price Thresholds, by Robert Meltz and Adam Vann.
As explained below at footnote 16, H.R. 6 contained language substantially similar to the
provisions of the Royalty Relief for American Consumers Act of 2007.
9 Andarko Petroleum Corporation acquired the Kerr-McGee Corporation in June of 2006.
10 See Kerr McGee Oil and Gas Corporation’s Memorandum in Support of Motion for Summary
Judgment, No. 2:06-CV-0439 (W.D. La., filed May 24, 2007).
11 U.S. Department of the Interior, Order to Report and Pay Royalties and Interest Due Under
Identified Offshore Federal Oil and Gas Leases (January 6, 2006).
12 Santa Fe Snyder Corp. v. Norton, 385 F. 3d 884 (5th Cir. 2004).
any location with royalty relief fashioned according to the Interior’s discretion. The
[Fifth Circuit] found that this power, however, was tempered by the next section,
where Congress replaced the Interior’s discretion to fashion royalty relief with a fixed
royalty suspension scheme based on volume and water depth. Thus, the royalty relief13
for Mandatory Royalty Relief leases is automatic and unconditional.
Based on the Fifth Circuit’s previous ruling, the district court found that Section 304
mandates royalty relief up to a certain minimum volume of production, regardless of the
market price of oil or natural gas.14 Therefore, the court concluded that the Department
of the Interior had “exceeded its Congressional authority” when it sought to collect
royalties on Kerr-McGee’s oil and gas production that did not exceed these volumetric
minimums, regardless of whether the oil and gas produced could be sold at prices in
excess of the price thresholds for royalty relief that had been included in the lease terms.15
The Impact of the Kerr-McGee Ruling on the Proposed
Royalty Relief for American Consumers Act of 2007
Since the Kerr-McGee ruling was issued on October 30, 2007, there has been
extensive congressional interest in the impact of the ruling on the proposed Royalty Relief
for American Consumers Act of 2007, as described above. Specifically, there is confusion
as to how the ruling might affect the restrictions that section 7504 seeks to impose on
holders of “covered leases.” As discussed above, section 7504 requires that persons who
hold “covered leases” either: (1) renegotiate their leases to include price thresholds;16 (2)
pay a “conservation of resources” fee as set forth in the section; or (3) forfeit eligibility
for future oil or gas production leases in the Gulf of Mexico.17
Section 7504 and the legislative efforts that preceded it18 have generally been
described as efforts to remedy a perceived “error” or “oversight” in the 1998 and 1999
deep water leases by forcing renegotiation of those leases to include royalty relief price
thresholds, or by using the “conservation of resources” fee structure to recover from these
leaseholders amounts that had previously been calculated to be roughly the same amount
13 Kerr-McGee Oil & Gas Corp. v. Allred, No. 2:06-CV-0439, slip op. at 7-8 (W.D. La. October
14 Id. at 8-9.
15 Id. at 9.
16 One concern that has been raised is whether the court’s ruling, if upheld on appeal, would
impact the authority of the Department of the Interior to renegotiate the “covered leases.”
Because section 7504, if enacted, would represent a new congressional grant of authority to an
administrative agency, this authority would likely supercede any perceived limitations of
authority under existing statutes. However, in order to avoid confusion on the matter, Congress
might be well served to explicitly state that this new authority supercedes any limitations on the
Department of the Interior’s authority with respect to negotiating the terms of the “covered
leases” that were previously in effect.
17 H.R. 3221 at section 7504.
18 Section 204 of H.R. 6, as passed by the House on January 18, 2007, contained a substantially
similar provision. The Senate-passed version of H.R. 6 does not contain a similar provision.
as would be owed if price thresholds had been in place.19 The recent ruling by the U.S.
District Court for the Western District of Louisiana, if upheld, would effectively eliminate
the distinction between the 1998 and 1999 deep water leases, which do not include price
thresholds, and the 1996, 1997 and 2000 deep water leases, which contain price
thresholds that are not enforceable because they are in violation of congressional intent
in enacting section 304 of the DWRRA.
If none of the leases issued pursuant to section 304 of the DWRRA contains royalty
relief provisions that are subject to price thresholds, then it appears that all of these leases
(i.e., all deep water leases issued between 1996 and 2000) would be “covered leases” as
that term is defined in the proposed act. As noted above, section 7504(d)(1) defines a
“covered lease” as “a lease for oil or gas production in the Gulf of Mexico that is ... issued
by the Department of the Interior under Section 304 of the Outer Continental Shelf Deep
Water Royalty Relief Act ... and ... not subject to limitations on royalty relief based on
market prices that are equal to or less than the price thresholds” described in the
DWRRA.20
It is important to note that the definition of “covered leases” is not restricted to leases
without price thresholds in their terms, or any other definition that would be contingent
upon the language in the leases. If this were the case, then only the 1998 and 1999 leases
would be “covered leases,” because the 1996, 1997 and 2000 leases contain price
threshold language. However, the definition of “covered leases” in section 7504(d)(1)
encompasses any lease that is not “subject to limitations on royalty relief” based on oil or
natural gas market prices. Thus, if the Western District of Louisiana decision is affirmed
on appeal, then it appears that none of the leases issued between 1996 and 2000 would be
“subject to limitations on royalty relief based on market price,” and thus all of these leases
may be “covered leases” under the proposed act. As a result, any entity that holds a deep
water lease issued between 1996 and 2000 may be ineligible for future oil or natural gas
production leases in the Gulf of Mexico pursuant to section 7504(a) of the proposed act
until that entity either renegotiates the lease in question or pays a “conservation of
resources” fee.
If Congress does wish to encourage recovery of royalties on all leases issued
pursuant to section 304 of the DWRRA between 1996 and 2000 that are limited by both
price and volumetric thresholds, it could likely do so by passage of the proposed Royalty
Relief for American Consumers Act of 2007 as it is currently worded in sections 7501-
7505 of H.R. 3221. This option could affect most companies operating in the deep water
OCS area. If Congress wishes to restrict the scope of the proposed act to the 1998 and
1999 leases that did not contain price thresholds, it might consider amending the
definition of a “covered lease” accordingly.
19 The conservation of resources fee is set in the bill at $9 per barrel of oil and $1.25 per million
Btu of natural gas (both in 2005 dollars) for all production years in which the price threshold is
exceeded.
20 H.R. 3221, section 7504(d)(1).