## Facts

- Marathon Oil Company held a 50% working interest in oil and gas leases in Alaska’s Kenai Field Unit and produced natural gas that was sold to multiple outlets, including an LNG plant whose LNG was sold in Japan.
- Federal lease royalty clauses required payment of a 12.5% royalty based on the “reasonable value” of production, computed under federal oil and gas operating regulations.
- The governing regulation provided that the agency would determine the “estimated reasonable value” for royalty purposes and that royalty value could not be less than the lessee’s “gross proceeds” from the sale.
- For gas used to produce LNG exported to Japan, Marathon calculated royalties using a lower domestic contract price for unliquefied gas rather than the higher value reflected by LNG export sales.
- The Department of the Interior’s royalty administrators (USGS/MMS) issued valuation orders applying a netback method: starting with the Japan LNG sales price and subtracting liquefaction and transportation costs, plus an allowed return on LNG plant investment, to estimate upstream gas value.
- Marathon objected, altered its valuation methodology, and did not fully comply with subsequent agency directives applying the agency’s formulas.
- Marathon sued for declaratory and injunctive relief; the United States, the State of Alaska, and Cook Inlet Region, Inc. (an entitled royalty beneficiary) defended the orders, and CIRI asserted a counterclaim for underpaid royalties.

## Issues

1. Whether the agency could lawfully determine “reasonable value” for royalty purposes using a netback formula derived from Japan LNG sales rather than Marathon’s domestic contract price for unliquefied gas.
2. Whether the regulation’s “gross proceeds” clause required acceptance of Marathon’s domestic contract price as the royalty base for LNG-feed gas.
3. Whether the lease reservation allowing the Secretary to establish reasonable minimum royalty values supported the netback-based valuation orders.
4. Whether the challenged valuation orders were valid and enforceable, requiring additional royalty payments.

## Decision

- The court upheld the agency’s authority to value production for royalty purposes using a netback methodology tied to LNG export sales.
- The court rejected Marathon’s argument that the domestic contract price controlled royalty valuation for LNG-feed gas.
- The court treated the “gross proceeds” requirement as a floor that did not bar the agency from determining a higher reasonable value reflecting LNG export economics.
- The court sustained the validity of the valuation orders and denied Marathon’s request to invalidate or enjoin their enforcement.

## Legal Principles

- When leases require royalties based on “reasonable value” as determined under governing regulations, the responsible agency has broad discretion to select a reasonable valuation method consistent with the regulatory text.
- A “gross proceeds” provision sets a minimum royalty value based on proceeds from the relevant sales; it does not cap royalty value at an internal or domestic pricing measure chosen by the lessee.
- Where a lessee processes and markets production downstream without a comparable arm’s-length upstream sale, a netback method that deducts appropriate post-production costs and allows a reasonable return may be used to approximate upstream value.
- A lease clause reserving to the Secretary the right to establish reasonable minimum values supports agency action setting royalty value to reflect the economic value realized from the production’s ultimate disposition.

## Conclusion

The court held that the Department of the Interior acted within its lease and regulatory authority by valuing Kenai Field gas used for exported LNG through a netback from Japan LNG sales, and it refused to confine royalty valuation to Marathon’s lower domestic contract price.


Marathon Oil Co. v. United States, 604 F. Supp. 1375 (D. Alaska 1985)