## Facts

- The Department of the Interior (DOI), through the Minerals Management Service (MMS), administers royalty valuation for natural gas produced under federal and Indian leases.
- Federal leases require royalties as a fraction of the “value” of gas produced and incorporate DOI regulations, including those later promulgated.
- Historically, DOI used a “gross proceeds” approach for royalty valuation, allowing limited deductions (notably certain transportation costs when sales occurred away from the lease), while treating marketing costs as non-deductible.
- After Federal Energy Regulatory Commission (FERC) orders restructured pipeline access, producers increasingly sold gas through downstream transactions rather than at the wellhead.
- In 1998, DOI issued revised gas valuation regulations to address the changed market structure, retaining a gross-proceeds baseline and codifying the “marketable condition” and “duty to market” doctrines.
- The 1998 rules treated specified downstream marketing-related costs as non-deductible when incurred to satisfy the lessee’s obligation to market production and deliver it in marketable condition.
- Independent Petroleum Association of America (IPAA) challenged the 1998 regulations, arguing DOI exceeded statutory and contractual authority by extending the duty to market downstream and by disallowing deductions for post-lease marketing-related costs.
- The district court largely invalidated the challenged provisions; DOI appealed.

## Issues

1. Whether DOI has statutory authority to define royalty “value” using a gross-proceeds framework that limits deductions for downstream costs.
2. Whether DOI may interpret federal and Indian leases to impose a lessee duty to place gas in marketable condition and to market it at no cost to the lessor, notwithstanding downstream sales after FERC restructuring.
3. Whether particular 1998 regulatory provisions classifying certain downstream costs as non-deductible marketing/marketability costs were arbitrary, capricious, or otherwise unlawful under the Administrative Procedure Act.

## Decision

- The D.C. Circuit affirmed in part, reversed in part, and remanded.
- The court upheld DOI’s general authority to use a gross-proceeds methodology for gas royalty valuation under federal and Indian leases.
- The court sustained DOI’s core “marketable condition” and “duty to market at no cost to the lessor” doctrines, including their application in a downstream-sales environment.
- The court accepted DOI’s general distinction between deductible transportation and non-deductible marketing or value-enhancement activities.
- The court nevertheless set aside or limited certain specific regulatory applications where DOI’s treatment of particular downstream cost categories lacked adequate statutory grounding or reasoned explanation.

## Legal Principles

- When Congress delegates broad authority to an agency to administer royalty valuation, courts generally defer to reasonable agency interpretations of ambiguous statutory terms such as “value.”
- Under federal oil and gas leasing, the lessee may be required to bear the costs to place production in marketable condition, and to perform marketing functions, without charging those costs to the lessor through royalty deductions.
- A gross-proceeds valuation approach may lawfully permit only narrow categories of deductions; marketing and marketability costs may be treated as non-deductible even when incurred downstream.
- FERC-driven changes in gas marketing and pipeline access do not, by themselves, eliminate the lessee’s no-cost marketing obligation for federal and Indian lease royalties.
- Although agencies may draw regulatory lines between transportation and marketing/enhancement costs, specific classifications must be supported by reasoned decisionmaking consistent with the governing statutes, lease terms, and the agency’s explained policy.

## Conclusion

The court largely sustained DOI’s 1998 gas royalty valuation framework—gross proceeds with a no-cost duty to achieve marketable condition and to market production—while requiring tighter justification for particular downstream cost classifications that DOI treated as non-deductible.


Independent Petroleum Ass'n of Am. v. DeWitt, 279 F.3d 1036 (D.C. Cir. 2002)