## Facts

- Devon Energy Corporation held federal leases to produce coalbed methane (CBM) in Wyoming and owed royalties to the United States based on production value.
- CBM generally requires compression and dehydration to satisfy pipeline specifications and reach the purchaser.
- Interior’s gas royalty valuation regulations included a “marketable condition rule,” requiring the lessee to place gas in marketable condition at no cost to the lessor, while allowing deduction of certain transportation costs in computing royalty value.
- Devon relied on Interior guidance materials (including a “Dear Operator” letter) that it read as permitting deduction of some compression and dehydration costs as transportation expenses, and applied that approach for several years.
- After Devon sought confirmation of its method, the Department of the Interior issued an order concluding that compression and dehydration needed to make CBM pipeline-quality were costs of placing gas into marketable condition and therefore not deductible as transportation.
- Interior required Devon to recalculate royalties retroactively and pay additional amounts reflecting inclusion of the disputed costs in the royalty base.
- Devon challenged the final agency action under the Administrative Procedure Act; the district court upheld Interior’s order, and Devon appealed.

## Issues

1. Whether Interior reasonably interpreted its “marketable condition rule” to treat compression and dehydration necessary to meet pipeline requirements as non-deductible marketable-condition costs rather than deductible transportation costs.
2. Whether Interior’s position unlawfully departed from prior agency guidance or operated as an impermissible retroactive change when applied to Devon’s past royalty payments.

## Decision

- The D.C. Circuit affirmed the judgment upholding Interior’s final order.
- The court held Interior’s interpretation of the marketable condition rule was reasonable and consistent with the regulation’s text.
- The court accepted Interior’s distinction between costs to make gas marketable (borne by the lessee) and costs to transport gas after it is marketable (potentially deductible).
- The court rejected Devon’s reliance on guidance materials as establishing a binding, contrary agency interpretation.
- The court held Interior’s enforcement of its interpretation against past conduct was not unlawful retroactive rulemaking under the APA.
- Certiorari was denied.

## Legal Principles

- Under the federal gas “marketable condition rule,” the lessee must bear, without royalty deduction, the costs required to place production into a condition acceptable for ordinary market sales.
- An agency may reasonably classify compression and dehydration as non-deductible marketable-condition costs when those processes are required to achieve pipeline-quality gas, even if they are also practically necessary for downstream delivery.
- When a regulation is ambiguous on the line between “marketing/conditioning” and “transportation,” a reasonable agency interpretation is entitled to judicial deference.
- Reliance on nonbinding or ambiguous agency guidance does not bar later enforcement of a reasonable interpretation absent a prior definitive, authoritative contrary position.
- Applying a reasonable interpretation of an existing regulation to prior periods through an enforcement order is not impermissibly retroactive absent a foreclosing prior binding interpretation or unfair surprise of the kind prohibited by administrative law.

## Conclusion

The D.C. Circuit upheld Interior’s requirement that Devon include compression and dehydration costs necessary to render CBM pipeline-quality in the royalty valuation base, deferring to Interior’s reasonable reading of the marketable condition rule and rejecting claims of inconsistency and unlawful retroactive application.


Devon Energy Corp. v. Kempthorne, 551 F.3d 1030 (D.C. Cir. 2008), cert. denied sub nom. Devon Energy Corp. v. Salazar, 558 U.S. 819 (2009)