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Energy Law Exchange

March 1, 2013

A Decade’s Worth of Coal Sales to be Scrutinized by Interior, Senate

February saw outgoing Secretary of the Interior Ken Salazar respond to a joint letter by leaders of the Senate Energy and Natural Resources Committee questioning Interiors management of royalties from coal mined on federal and tribal lands, especially in the Powder River Basin of Wyoming and Montana.

The request was sent by Chairman Ron Wyden (D-OR) and Ranking Member Lisa Murkowski (R-AK) in January and was triggered by press reports that raised questions about whether taxpayers were receiving royalties based on the actual value of the coal derived from federal lands.

An article in Thomson Reuters asserted that coal companies might be violating provisions of the Mineral Leasing Act of 1920 and applicable lease provisions and royalty regulations that set out royalty and valuation requirements for coal. Specifically, the article alleged that coal companies were selling coal to in-house trading affiliates, which in turn sold the coal to buyers on the international market for a premium. The article then alleged that coal producers utilized this arrangement in order to report a lower sales price that did not reflect the actual value of coal that was ultimately exported to overseas buyers and sold at a premium.

On February 7, 2013, Secretary Salazar responded to the Senators concerns promising an investigation. Specifically, he directed the Interior Office of the Inspector General to investigate allegations regarding coal sales in the Powder River Basin to affiliated export purchasers or broker/marketers. Other actions include:*Fast-tracking reviews of recent coal sales, with an Interior task force undertaking reviews of sales summaries and contracts between 2009 and 2011; and

*Reviewing older sales for misreporting: after the fast track reviews have been completed, the task force will review mines and leases between 2001 and 2008 according to risk-based criteria. Geographically, both reviews will initially focus on the Powder River Basin, before expanding to other Western coal-producing states such as Utah and Colorado.

Lease Provisions and Royalty Regulations****

Under Department of the Interior Office of Natural Resources Revenue (ONRR) regulations that apply to most federal coal leases, producers must value coal for royalty purposes that is sold non-arms-length to an affiliate using the first applicable of a series of benchmarks. 30 C.F.R. 1206.257(c). The first benchmark is the sales price to the affiliate provided that the gross proceeds from the sale are within the range of prices derived from comparable arms-length contracts between unaffiliated parties for like-quality coal produced in the same area. Id. 1206.257(c)(2)(i). If this first benchmark is not applicable, then sales to an affiliate must be valued using the next applicable benchmark as follows: (ii) prices reported for that coal to a public utility commission; (iii) prices reported for that coal to the Energy Information Administration; (iv) other relevant information including, but not limited to publicly available spot market prices, or information submitted by the lessee concerning circumstances unique to a particular lease operation or the saleability of certain types of coal and, finally, (v) a net-back method. Id. 1206.15 7(c)(2)(ii-v).

A similar set of product valuation benchmarks was used in the 1990s to value oil production for royalties on federal leases. The oil valuation regulations were subject to a range of legal interpretations, and much administrative and False Claims Act litigation. ONRRs predecessor, the Minerals Management Service, made substantial changes to the oil valuation regulations beginning in 2000 to mandate use of published indexes and, later, futures prices to value oil sold to an affiliate in many circumstances. However, the agency left intact the coal valuation regulations.

The joint letter may be seen as a part of a broader push by some in the 113th Congress to exercise more stringent oversight of federal mineral rights and royalties beyond traditional oil and gas targets. It remains to be seen whether the next Secretary of the Interior will share the same sentiments.