BEFORE THE STATE BOARD OF EQUALIZATION
FOR THE STATE OF WYOMING
IN THE MATTER OF THE APPEAL OF )
EOG RESOURCES INC. FROM A ) Docket No. 2000-71
PRODUCTION TAX AUDIT DECISION OF )
THE DEPARTMENT OF REVENUE )
(Production Years 1992-1996) )
FINDINGS OF FACT
CONCLUSIONS OF LAW
DECISION AND ORDER
Lawrence J. Wolfe, Holland & Hart LLP, Cheyenne, Wyoming; Judith M. Matlock, Davis, Graham & Stubbs, LLP, Denver, Colorado; and Steven P. Williams, Assistant General Counsel, North America, EOG Resources, Inc., Denver, Colorado, representing EOG Resources, Inc., Petitioner.
Martin L. Hardsocg, Senior Assistant Attorney General, for the Wyoming Department of Revenue (Department), Respondent.
Pursuant to notice duly given to all parties, this matter came on for hearing on Monday, the 22nd day of October, 2001, at 10:09 a.m., in hearing room 1299, Herschler Building, 122 West 25th Street, Cheyenne, Wyoming, before the State Board of Equalization (Board) consisting of Edmund J. Schmidt, Chairman, Roberta A. Coates, Vice-Chairman, and Sylvia Lee Hackl, Board Member, with Gayle Stewart, Hearing Officer, presiding. This decision is based on the testimony presented at the hearing, a review of the transcript and exhibits of the hearing proceedings, the closing arguments and written proposed findings of fact and conclusions of law submitted by the parties and the record on appeal. This case arises from an audit conducted by the Wyoming Department of Audit (DOA) and final administrative decision of the Department revising the valuation of Petitioners 1992 through 1996 natural gas production in Lincoln and Sublette Counties for ad valorem and severance tax purposes.
ALL STATUTORY CITATIONS USED IN THIS DECISION AND ORDER REFERENCE TITLE 39, PRIOR TO RECODIFICATION WHICH WAS EFFECTIVE MARCH 6, 1998.
Upon application of any person adversely affected, the Board is mandated to review final decisions of the Department, and "[h]old hearings after due notice in the manner and form provided in the Wyoming Administrative Procedures Act [Wyo. Stat. §§ 16-3-101 through 16-3-115] and its own rules and regulations of practice and procedure." Wyo. Stat. § 39-1-304(a)(ix).
The Board is required to "[d]ecide all questions that may arise with reference to the construction of any statute affecting the assessment, levy and collection of taxes, in accordance with the rules, regulations, orders and instructions prescribed by the department." Wyo. Stat. § 39-1-304(a)(iv). The rules of practice and procedure for appeals before the Board involving tax matters contemplate appeals from final administrative decisions of the Department. Rules, Chapter 2, § 3, Wyoming State Board of Equalization. The rules require appeals be filed with the Board within thirty days of any final administrative decision. Rules, Chapter 2, § 5, Wyoming State Board of Equalization.
The DOA engaged an audit of Petitioners oil and gas production in Sublette and Lincoln Counties, Wyoming on August 27, 1997. The audit covered a period from October 1, 1992, through December 31, 1996. The Department issued a deficiency assessment based on the audit, which was appealed by Petitioner on February 29, 2000.
The document which gave rise to this tax controversy is a volumetric production payment transaction (VPP) between Petitioner and Cactus Hydrocarbon 1992-A Limited Partnership II (Cactus) dated September 25, 1992. Pursuant to the agreements between Petitioner and Cactus, and in exchange for $326,775,000 and extensive undertakings set forth in the transaction documents, Petitioner conveyed to Cactus a production payment interest in reserves in the ground. A production payment is an interest carved out of the leasehold estate and is considered to be an interest in real property in the nature of an overriding royalty, but of a limited duration.
Petitioner operated the properties subject to the VPP and produced the oil and gas, including the oil and gas attributable to Cactus share of the reserve. At points located near each well site (and identified in the VPP documents) the minerals owned by Cactus were delivered by Cactus to Petitioner. Simultaneously, pursuant to one of the four VPP documents, the Exchange Agreement, Petitioner was required to deliver gas to Cactus at four points in Colorado and Texas. The amounts of gas delivered at the downstream locations were equivalent on an MMBTU basis to the volumes of oil, gas and condensate delivered by Cactus to Petitioner at the Wyoming locations.
Petitioner sold all the production from the wells subject to Cactus VPP, both the production received from Cactus and Petitioners own production, in the same way. Natural gas was gathered at the well and transported by Williams Field Service to the Opal Gas Processing Plant near Opal, Wyoming. At the Opal plant the natural gas liquids (NGLs) were separated and sold. The remaining gas was sold in arms length and non-arms length transactions at the outlet of the Opal Plant. Oil and condensate were sold at the outlet of the storage tanks at each well site.
On March 3, 1998, during the course of the audit, the Department informed Petitioner that it had determined that the delivery of production from Cactus to Petitioner at the meters in Wyoming was a bona fide arms length sale at the point of valuation pursuant to Wyoming Statute Section §39-2-208(c). The Department determined that the consideration for the sale from Cactus to Petitioner was terms equivalent to cash, which the Department viewed as the index value of the gas delivered by Petitioner to Cactus at the four downstream points of receipt in Colorado and Texas.
DOA, using the Department interpretation, calculated an additional increment of value for each well and each month during the audit period. The increment of value was based on the difference between the weighted average index prices at the four out-of-state delivery points compared to the weighted average price of arms length and non-arms length sales prices for residue gas at Opal. The Department summed all of the increments of value for each well for each month to determine the final tax amount due and assessed interest for the entire audit period on the additional assessment.
Petitioner argues that the audit findings are erroneous because (1) there was no arms length sale at the wellhead; (2) the delivery of gas from Cactus to Petitioner is not a sale, but is simply one part of the large set of obligations undertaken by Petitioner as a result of entering into the VPP transaction; (3) the VPP is a complex financing transaction in which the exchange of the Wyoming production for gas in Colorado and Texas was a part of the repayment obligation that Petitioner undertook; (4) the Department improperly treated the exchange as a stand-alone agreement, when the four VPP documents are completely integrated and must be interpreted as a whole; (5) the Department erred by considering the delivery of gas in Colorado and Texas to be terms equivalent to cash; and (6) the Department erred by imputing to Petitioner the index prices referenced in contracts between Cactus and Enron Gas Marketing to which Petitioner is not a party. Petitioner contends that it properly valued and reported the Wyoming production on the basis of sales at the well head and at Opal under Wyoming Statute Section 39-2-208(d).
The Department argues that there was an arms length sale at the meter locations where Cactus delivered its volumetric share of production to Petitioner. The Departments position is that Wyoming Statute Section 39-2-208(c) thus applied and that the consideration for the sale was the gas delivered at the four points in Colorado and Texas. The Department contends that consideration for such a sale was terms equivalent to cash (i.e., the index prices at the four out-of-state points). The Department also argues that the VPP is not a financing transaction: rather, the VPP documents adopt index prices at the four downstream locations. Finally, the Department argues that the Master Sale Agreement and the Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing incorporate the VPP documents, and thus validate the use by the Department of the index prices as a basis for valuation.
Petitioner makes an alternative argument that if the assessment is affirmed, Petitioner should not be assessed interest. Petitioner contends that it was paying its taxes in accordance with the instructions of the Department in 1990 through 1993 to use the comparable value method to value sales not occurring at the well head, or that were non-arms length. Petitioner argues that the Department changed its own initial valuation method for the 1990 through 1993 audit and did not adopt the valuation method employed in the 1992 though 1996 audit until after the taxes for the audit period were fully reported and paid. Petitioner contends it did not know nor could it reasonably have known that it was not paying its taxes in accordance with the Departments interpretation of the statutes, and thus it should not be liable for interest under Wyoming Statute Section 39-2-214(f).
The Department argues that interest should be assessed from the inception of the production and that Petitioner should have known the proper way to report. Moreover, the Department argues Petitioner had an opportunity under the statutes to request a valuation opinion from the Department and failed to do so.
The following issues have been raised with respect to the DOA audit of Petitioner and the subsequent Department determination and final assessment letter regarding the valuation of Petitioners 1992 through 1996 natural gas production in Lincoln and Sublette Counties:
1. Is the Department correct in determining that an arms length sale of the VPP gas occurred at the wellhead between Cactus Hydrocarbon and Petitioner, and that the value of that gas is the index price in Colorado and Texas which represents terms equivalent to cash under Wyoming Statute Section 39-2-208(c) and Department of Revenue Rules Chapter 6, Section 4(l)? or;
2. Is Petitioner correct in interpreting the delivery of Cactus volumetric share of production to Petitioner in Wyoming as simply one step in a large set of duties undertaken by Petitioner to satisfy its obligations under the VPP transactions, so that the actual value of the VPP gas is represented by the index price of the gas as sold by Petitioner at Opal to third parties?
FINDINGS OF FACT
History of EOG Operations in Wyoming
1. Petitioner, EOG Resources, Inc. (f/k/a Enron Oil & Gas Company), owns and operates oil and gas properties in southwestern Wyoming in Lincoln and Sublette Counties. [Stipulated Summary of Uncontested Facts, ¶1]. Petitioners predecessors in interest have owned and operated wells in Lincoln and Sublette Counties since the 1950s. Petitioners wells produce primarily from the LaBarge Platform and the Moxa Arch formations. [Trans. Vol. I, p. 56; Petitioner Exhibit 107].
2. Petitioner is an oil and gas producer created in 1989 as Enron Oil & Gas Company. Its common stock has, since its inception, been publicly traded on the New York Stock Exchange. When it was initially created, Enron Corporation (Enron) owned 80% of Petitioners stock. Over the next several years, Enron sold its stock ownership down so that it only owned 53% by 1995. In 1999, Enron sold its remaining stock interest and Enron Oil & Gas Company became EOG Resources, Inc., wholly separate from Enron. [Trans. Vol. I, p. 55. Petitioner Exhibit 139, p. 00154].
3. Petitioners gas wells produce natural gas and condensate. When gas is produced to the surface it contains water and liquid hydrocarbon, called condensate, which is a very light oil. The water must be separated because it can corrode the pipeline and restrict gas flow. After the free water is separated, additional water is removed in the dehydrator. The separation and dehydration occurs at the well. [Trans. Vol. I, pp. 78-79; Petitioner Exhibit 139, p. 00158]. Petitioner introduced exhibits, including photographs, showing a typical well site configuration. The exhibits show that the separator and the dehydrator are generally located in a small building a short distance from the wellhead. [Petitioner Exhibit 109, pp. 00043a, 449].
4. The outlet of the dehydrator is upstream of the orifice meter. The orifice meter is that point at which the gas is measured. It also may serve as the custody transfer point as identified in Wyoming Statute Section 39-2-208 (b)(ii). [Trans. Vol. I, p. 81; Petitioner Exhibit 141].
5. After separation and dehydration, the gas is transported by Williams Field Service (WFS), an independent third party, to the Opal Gas Processing Plant, a distance of approximately 40 miles. [Trans. Vol. I, pp. 57, 77-78; Petitioner Exhibit 108]. The Opal Plant is recognized as a major market center. [Trans. Vol. II, p. 322; Trans. Vol. III, p. 464].
6. The Opal market is served by three interstate pipelines, Northwest Pipeline, Kern River Pipeline and CIG Pipeline. [Trans. Vol. I, pp. 57-58; Trans. Vol. II, p. 323].
7. At the Opal Gas Processing Plant, Natural Gas Liquids such as propane and butane are removed from the gas stream to be used for home heating and other purposes. These NGLs usually have a higher value than if sold as Btus as part of the gas stream. [Trans. Vol. I, pp. 75-76]. The NGLs and the remaining residue gas, which consists primarily of methane, are sold at the tailgate of the Opal Plant. [Trans. Vol. III, pp. 462-463].
8. The NGLs are valued at the Mont Belvieu, Texas, price less transportation and fractionation charges. Mont Belvieu is a large fractionation plant in Texas. [Trans. Vol. III, p. 467].
9. Residue gas is sold by Petitioner in both arms-length and non-arms-length sales at the tailgate of the Opal Plant. [Trans. Vol. III, pp. 464-465].
10. Oil and condensate are placed into tanks adjacent to the wellhead and then sold. [Trans. Vol. I, pp. 82-83].
11. An index price is a published average price for natural gas which buyers and sellers have agreed to pay or receive at a particular time and location. [Trans. Vol. II, pp. 315-316]. Index prices for natural gas are published in various daily and weekly publications such as Inside F.E.R.C.s Gas Market Report, Natural Gas Week, Gas Daily, and Natural Gas Intelligence. [Trans. Vol. II, p. 316].
12. Index prices are determined by publishers who conduct surveys of buyers and sellers to ascertain the average selling price of natural gas. For example, Inside F.E.R.C.s Gas Market Report states that prices quoted in its table are obtained firsthand in confidential surveys of actual buyers and sellers. [Trans. Vol. II, p. 316].
13. Index prices are used as a price discovery mechanism to inform gas sellers and buyers of the markets at various locations. [Trans. Vol. II, p. 315].
14. Index prices are only published for major market centers where there are sufficient buyers and sellers conducting transactions to generate the liquidity needed to establish a meaningful index price. [Trans. Vol. II, p. 317].
15. It is a common practice in the natural gas industry for sellers and buyers to establish sales prices in contracts for locations where there is no published index price by referencing a published index in the area with a discount (such as the index price minus so many cents) or a premium (such as the index price plus so many cents) to reflect the parties estimate of value at the place of sale. [Trans. Vol. II, pp. 316-318].
16. Index prices vary between index pricing markets based upon supply and demand at those markets which, in turn, are a function of the strength or weakness of the markets served by gas supplies. [Trans. Vol. II, p. 323; Petitioner Exhibit 121].
17. A production payment is a common form of an oil and gas financing transaction that has been utilized for decades. [Stipulated Summary of Uncontested Facts, ¶4]. The United States Supreme Court recognized a production payment in the 1940 case of Anderson vs. Helvering, 310 US 404, 60 S.Ct. 95, 284 L.Ed 1277 (1940). [Trans. Vol. I, pp.95, 100].
18. A production payment is a method of raising capital to finance acquisition, exploration or development of oil and gas properties. [Trans. Vol. I, p. 95]. It is used most often when conventional financing, such as a bank loan or mezzanine financing, is not available. [Trans. Vol. I, p. 95; Trans. Vol. II, p. 340].
19. Production payment financing is accomplished by the sale from a producer of a production payment to a buyer who is willing to provide the necessary capital. [Trans. Vol. I, pp. 95-96]. The buyer of a production payment purchases an interest in an oil and gas lease which then entitles it to a share of oil and gas produced for a limited period of time, free and clear of any of the costs of production. [Trans. Vol. I, p. 96].
20. A production payment is an interest in real property and is similar to an overriding royalty interest. [Stipulated Summary of Uncontested Facts, ¶4; Trans. Vol. I, p. 96]. The only significant difference is that a production payment is for a limited term. [Trans. Vol. I, p. 96]. Volumetric production payments continue until a specific quantity of gas is delivered. Dollar-denominated production payments continue until a specified amount of proceeds are received. [Trans. Vol. I, p. 97].
21. The seller of a production payment must produce the reserves that are attributable to the production payment and deliver the production payment buyers share of production, but the seller has no personal liability if the reserves run out before the production payment is fully paid. The buyer of the production payment thus takes the reserve risk. [Trans. Vol. I, pp. 97-98].
22. The buyer of a volumetric production payment also assumes the risk of price fluctuations in the market. [Trans. Vol. I, p. 99]. The buyer takes the risk of downward price fluctuations and receives the benefit of any upward price fluctuations. [Trans. Vol. I, p. 100].
23. For federal income tax purposes, the seller of a production payment is treated as if the seller had borrowed money and placed a mortgage on the mineral property as security for the loan. The principal payment is assumed to be the fair market value of the production at the time of delivery less interest imputed according to IRS regulations in effect on the date of closing of the production payment transaction. The speed of the imputed repayment of the principal depends on prices at the time of production. [Trans. Vol. I, pp. 101-102].
24. Production payment transactions commonly consist of three primary documents: a purchase and sale agreement, a conveyance, and a production and delivery agreement. There may also be other documents that are tailored to the specific transaction. [Trans. Vol. I, p. 106].
EOGs Volumetric Production Payment
25. Petitioner owned and operated over 800 wells in Sublette and Lincoln Counties. Petitioner had a significant lease position and reserve base, but because of low gas prices Petitioner was unable to finance additional development of the reserves. In 1992, in order to finance the development of its oil and gas reserves, Petitioner made the decision to enter into a volumetric production payment transaction. Among the reasons for this decision were: gas prices were at a very low level; there was a large asset base located near a large market center that needed additional development; and, because gas prices were so low, no other financing was available to develop the huge reserve base. Because of the unique reserve base, additional pipelines then coming to Opal, and the fact that Petitioners reserves were located only 50 miles away, Petitioner made the decision to enter into a volumetric production payment transaction. [Trans. Vol. II, pp. 361-362].
26. On September 25, 1992, Petitioner entered into a volumetric production payment transaction (the VPP) with Cactus Hydrocarbon 1992-A Limited Partnership (Cactus). The terms and conditions of the VPP transaction were set forth in documents, collectively called the VPP Documents:
a. Purchase and Sale Agreement between Enron Oil & Gas Company, as Seller, and Cactus Hydrocarbon 1992-A Limited Partnership, as Buyer, dated September 25, 1992. [Joint Exhibit 300].
b. Conveyance of Production Payment from Enron Oil & Gas Company, as Grantor, to Cactus Hydrocarbon 1992-A Limited Partnership, as Grantee, dated September 25, 1992 (Exhibit A to the Purchase and Sale Agreement). [Joint Exhibit 301].
c. Hydrocarbon Exchange Agreement by and between Enron Oil & Gas Company and Cactus Hydrocarbon 1992-A Limited Partnership, dated September 25, 1992 (Exhibit B to the Purchase and Sale Agreement). [Joint Exhibit 302].
d. Production and Delivery Agreement by and between Enron Oil & Gas Company, as Grantor and Cactus Hydrocarbon 1992-A Limited Partnership, as Grantee, dated September 25, 1992 (Exhibit C to the Purchase and Sale Agreement). [Joint Exhibit 304; Stipulated Summary of Uncontested Facts, ¶3; Trans. Vol. I, p. 113; Petitioner Exhibit 116].
e. Hydrocarbon Purchase and Sale Agreement dated September 28, 1992, by and between Cactus Hydrocarbons 1992 - A Limited Partnership and Enron Gas Marketing, Inc. [DOR Exhibit 522]
The Board finds that a fifth agreement (describer in subsection (e) above, which was discovered by the Department on the trip to Houston), should also be read together with the four VPP documents as an integrated whole.
27. Consistent with general practices of production payment financing, the VPP documents gave Cactus a non-operating, non-expense-bearing real property interest. The interest was free of cost risk and free of the expense of production, operations and delivery to the delivery point. Cactus interest was also free of any and all royalties, other burdens on production and all ad valorem, property, severance, gross production and other taxes and governmental charges other than income taxes. [Trans. Vol I, pp. 118-120, 125, 133; Joint Exhibit 301]. Additionally, pursuant to the VPP documents, Cactus agreed to look solely to the VPP hydrocarbons for satisfaction and discharge of the VPP and Petitioner would not be personally liable for the payment and discharge of the VPP. [Trans. Vol. I, p. 133]. Finally, as with all other volumetric production payments, the VPP was for a limited term which was originally the later of (a) June 30, 1996, or (b) when any Basis Adjustment Amount outstanding as of June 30, 1996, had been reduced to zero. [Trans. Vol. I, p. 125]. The Basis Adjustment Amount was an additional quantity of gas which could have been owed by Petitioner to Cactus if there had been deficiencies in deliveries of the scheduled quantities prior to June 30, 1996. [Trans. Vol. I, p. 125]. The term of the VPP was extended to March 31, 1999, by an amendment dated October 1, 1993, and the production payment daily and monthly volumes were reduced. [Joint Exhibit 301c; Trans. Vol. 1, pp. 128-129].
28. In the VPP documents, Petitioner made representations and warranties regarding the accuracy of reserve reports and its financial statements, both matters of concern to production payment purchasers. [Trans. Vol. I, pp. 116-117, 120-121].
29. The structure of Cactus and the relationship between Cactus and Petitioner was set forth in a letter from Petitioner to the DOA. Enron Big Piney Corp. was the general partner and it held a one percent ownership interest in Cactus. The remaining ninety-nine percent interest in Cactus was owned by its limited partner Campanile Charities. [Department Exhibit 508].
30. Effective August 1, 1994, and prior to the dissolution of Cactus, the VPP was transferred to Cactus Hydrocarbon III Limited Partnership (Cactus III). Cactus IIIs general partner and 1% owner was Enron Cactus III Corp. The remaining 99% interest in Cactus III was owned by Cactus Hydrocarbon III Production Payment Trust. In 1995 Cactus Hydrocarbon 1992-A Limited Partnership was dissolved. [Department Exhibit 508].
31. The capital contributions to Cactus Hydrocarbon 1992-A Limited Partnership by the initial partners were provided by Enron Big Piney Corp., as general partner in the amount of $163,387.50, and by Campanile Charities, Inc., as the sole limited partner in the amount of $16,175,362.50, totaling $16,338.750.00. [Department Exhibit 507, p. 000050].
32. The remaining participants in the original financing transaction were comprised of a group of banks which loaned funds to Cactus Hydrocarbon 1992-A Limited Partnership. These loan proceeds totaled $310,436,250.00. [Department Exhibit 505, p. 000022]. Taking the general and limited partners capital contributions, along with the loan proceeds advanced by the group of banks, the total amount of funds advanced to Cactus was $326,775,000.00. This is the stated amount of the production payment in the Purchase and Sale Agreement, and was paid to Petitioner by Cactus in exchange for the conveyance of the production payment to Cactus and the various undertakings by Petitioner pursuant to the VPP Documents.
33. The VPP transaction consisted of Petitioner selling and conveying to Cactus, and Cactus purchasing and accepting from Petitioner, a volumetric production payment for a purchase price of $326,775,000.00, and the parties executing and delivering the four VPP documents. [Joint Exhibit 300, ¶ 2.01].
34. As a result of the obligations Petitioner undertook in connection with the VPP transaction, Petitioner commenced a substantial well development program, which resulted in the drilling of 284 new wells and the investment of $86.8 million.
New Wells drilled and completed
78 wells + recompletions
91 wells + recompletions
29 wells + recompletions
76 wells + recompletions
274 new wells
[Trans. Vol. II, pp. 387-389; Petitioner Exhibit 140, p. 00128].
35. Pursuant to one of the four VPP documents, the Hydrocarbon Exchange Agreement, Cactus delivered to Petitioner, at delivery points in Wyoming, Cactus volumetric share of production (oil, condensate, NGLs and gas), and Petitioner delivered equivalent MMBTU quantities of gas to Cactus at four delivery points in Colorado and Texas. [Joint Exhibit 302, Art. II, ¶ 1]. Petitioner took Cactus share of production and sold it along with Petitioners working interest share of production at the tailgate of the plant in Opal, Wyoming. [Trans. Vol. III, pp. 466, 544].
How EOG Reported and Paid Taxes.
36. Petitioner reported and paid taxes pursuant to Wyoming Statute Section 39-2-208(d). [Trans. Vol. III, pp. 495-497, 545; Petitioner Exhibit 110].
37. Petitioner reported and paid taxes in the same manner for all oil and gas production, both its own non-VPP working interest share of production and all the production covered by the VPP. [Trans. Vol. III, pp. 466, 544].
38. In 1990 and 1993 the Department issued memoranda to all oil and gas producers directing them to use the comparable value method to value the sales of production that were not sold by arms length sales at the wellhead. Petitioner complied with these instructions for the valuation of residue gas and NGL production. [Trans. Vol. III, pp. 498-499; Petitioner Exhibits 101 and 102].
39. Petitioner valued residue gas sold at the outlet of the Opal Plant on the basis of its arms length and non-arms length sales. Arms length sales were valued on the basis of the prices received from non-affiliated third parties. Non-arms length sales were valued on the basis of the arithmetic average of the three published pipeline indices for Northwest Pipeline, Kern River and Colorado Interstate Gas Company. [Trans. Vol. III, p. 464]. For example, in June of 1993 the arithmetic average of the three pipeline indices was $1.61, which was based upon the sum of the three index prices as published in Inside F.E.R.C.s Gas Market Report, June 1, 1993, divided by three. [Trans. Vol. II, p. 326; Petitioner Exhibit 129].
40. In order to arrive at the wellhead value, Petitioner subtracted the cost of processing at the Opal Plant and the cost of transporting the gas from the wellhead to the Opal Plant. [Trans. Vol. III, pp. 461-462]. The Department did not question the valuation method used by Petitioner to value the non-VPP gas sold at the Opal tailgate. [Trans. Vol. III, p. 544; Trans. Vol. IV, p. 688].
41. Oil and condensate were sold from tanks near the wellhead. Oil and condensate were valued on the basis of arms length and non-arms sales. Arms length sales were valued on the basis of the price received. Non-arms length sales were valued on the basis of the highest posted price paid in the area by other purchasers, plus any premium or bonus. [Trans. Vol. III, p. 476]. The Department did not question the valuation method used for oil and condensate for non-VPP production. [Trans. Vol. III, p. 544; Trans. Vol. IV, p. 688].
42. NGLs were valued at the price for sales at Mont Belvieu, Texas, fractionalization plant, minus a transportation and fractionation fee. [Trans. Vol. III, p. 467]. The Department did not question the valuation method used for NGLs. [Trans. Vol. IV, p. 728].
How the Department Valued the Volumetric Production Payment Gas.
43. Mineral taxpayers report their tax liability to the Department pursuant to a self-reporting tax system which requires that taxpayers report their tax liability to the Department. [Trans. Vol. IV, p. 705]. Wyo. Stat. §39-6-304(a). The Department is statutorily required to annually value and assess mineral property at its fair market value. [Trans. Vol. III, pp. 607-608]. Wyo. Stat. §39-2-202(a). Based upon information received or procured from the taxpayer, the Department is required to determine the fair market value for minerals following the production process. [Trans. Vol. III, p. 608]. Wyo. Stat. §39-2-202(a).
44. The Departments of Revenue and Audit learned through EOGs Annual Report that Petitioner had engaged in a transaction called a volumetric production payment, which was at first unfamiliar to either department. [Trans. Vol. III, p. 610].
47. The Department took the initiative to investigate what constituted a volumetric production payment to determine whether there might be unpaid tax liability. [Trans. Vol. III, p. 610].
48. In October of 1997, representatives from the Departments and the Attorney Generals Office attended a meeting with Petitioners representatives in Houston, Texas, to discuss the volumetric production payment transaction. [Trans. Vol. III, pp. 611-12].
49. Petitioners representatives at the meeting made a presentation on the volumetric production payment transaction and provided the States representatives with schematics or flow diagrams to assist in explaining how the VPP transaction worked. [Trans. Vol. III, p. 612].
50. The Departments of Revenue and Audit employees and a representative of the Attorney Generals Office then spent several days in Houston reviewing VPP contracts provided by Petitioner. [Trans. Vol. III, p. 612-13].
51. Following Petitioners presentation, and their own review of the VPP transaction documents, employees from the Departments of Revenue and Audit and the Attorney Generals Office had a good understanding of how the VPP transaction occurred, including that Cactus was assured an index price from locations in Texas and Colorado, in exchange for the Wyoming gas. [Trans. Vol. III, p. 613; Trans. Vol. IV, p. 713].
52. The Departments ultimate valuation determination was derived primarily from, and based upon, the information learned at the October 1997 meeting with Petitioners representatives and documents reviewed at the meeting. [Trans. Vol. III, pp. 614-15, 622-23].
The Hydrocarbon Purchase and Sale Agreement of September 28, 1992.
53. Petitioners representatives, at the October 1997 meeting in Houston, Texas, verbally represented that Cactus received index prices for gas received from Petitioner through the exchange agreement, which was corroborated through review of the Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing. [Trans. Vol. III, p. 622; Trans. Vol. IV, pp. 647-648; Department Exhibit 522].
54. Representatives reviewing flow charts provided by Petitioners representatives found that the VPP transaction clearly envisioned the sale of exchanged gas by Cactus to EGM or Enron Gas Marketing pursuant to the Hydrocarbon Purchase and Sale Agreement. [Trans. Vol. III, p. 621; Department Exhibit 502, p. 000005].
55. Petitioners representatives provided employees of the Departments of Revenue and Audit and the Attorney Generals Office with a Hydrocarbon Flow Summary which indicated that Cactus, holding marketable title to gas, sold the gas to Enron Gas Marketing for an index price. The Hydrocarbon Flow Summary states: Gas and other hydrocarbons actually flow directly from EOG to EGM. However, since title to hydrocarbons is owned by the Partnership [Cactus], hydrocarbons are depicted to move through the Partnership. [Trans. Vol. III, pp. 626-627; Department Exhibit 502, p. 000006].
56. Consistent with the flow charts, the Department understood that Cactus owned marketable title to the VPP gas and exchanged gas as set forth in the VPP documents. [Trans. Vol. III, pp. 627-628; Joint Exhibits 300-302, 304; Department Exhibits 501-504].
57. The Hydrocarbon/Cash Flow Summary provided by Petitioners representatives demonstrates that gas and oil are transferred to Cactus and sold to Enron Gas Marketing for index prices. It also demonstrates that Cactus Hydrocarbon III Production Payment Trust was and is a successor to Cactus. [Trans. Vol. III, pp. 628-629; Department Exhibit 502, p. 000007].
58. Cactus and Petitioner agreed in the Hydrocarbon Exchange Agreement that the Wyoming VPP gas would be transferred from Cactus to Petitioner and that in exchange Petitioner would transfer identical MMBTUs back to Cactus at four locations in Texas and Colorado, with a value to be determined by the index prices at the four locations in Texas and Colorado. [Trans. Vol. IV, pp. 660, 709-711, 713-716; Joint Exhibit 302; Department Exhibits 521, 522].
59. The Departments review of the Hydrocarbon Purchase and Sale Agreement, dated September 28, 1992, between Cactus and Enron Gas Marketing (as opposed to EOG), revealed the price Cactus received for the VPP gas was to be determined at the index prices situated at the four points in Texas and Colorado. [Trans. Vol. III, pp. 621-622; Department Exhibit 522].
60. Representatives from the Departments of Revenue and Audit and the Attorney Generals Office also reviewed and relied upon a Master Natural Gas Purchase and Sale Agreement, dated June 30, 1993, which was significant because it demonstrated that Cactus obligation to sell gas to Enron Gas Marketing was assumed by Cactus successor, Cactus Hydrocarbon III Limited Partnership (Cactus III). [Trans. Vol. IV, pp. 650-651; Department Exhibit 521].
61. The Master Natural Gas Purchase and Sale Agreement, also references the production payment documents and provides many of the same obligations imposed upon Cactus under the preceding agreement, the Hydrocarbon Purchase and Sale Agreement, including reference to index prices at the points of delivery in Texas and Colorado. [Trans. Vol. IV, pp. 654-655; Department Exhibit 521].
62. The Hydrocarbon Purchase and Sale Agreement, dated September 28, 1992, between Cactus and Enron Gas Marketing, specifically refers to the VPP documents and specific requirements in the VPP documents, including the payment of index prices from the four locations in Texas and Colorado. [Trans. Vol. III, pp. 622-623; Trans. Vol. IV, pp. 713, 716-718; Department Exhibit 522].
63. The Department concluded that the index prices received by Cactus, as reflected in the Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing, established the consideration, in terms equivalent to cash, received for transfer of the VPP gas produced in Wyoming. [Trans. Vol. III, p. 623; Trans. Vol. IV, pp. 650, 659-661, 713-716, 737-738; Joint Exhibit 307, p. 00211].
64. Pursuant to the Hydrocarbon Purchase and Sale Agreement, dated September 28, 1992, between Cactus and Enron Gas Marketing, Cactus is designated as the seller and Enron Gas Marketing, Inc. is designated as the buyer. [Trans. Vol. III, pp. 629-30; Department Exhibit 522, pp. 000329, 000332].
65. Pursuant to the Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing, Production payment documents was defined as the Conveyance, the Production and Delivery Agreement and the Exchange Agreement. Production and Delivery Agreement is defined as the Production and Delivery Agreement between Enron Oil & Gas Company and seller dated September 25, 1992, as the same may be amended, supplemented or modified from time to time. [Trans. Vol. III, pp. 631-632; Department Exhibit 522, p. 00332].
66. The Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing, references or incorporates all of the VPP documents between Cactus and Petitioner. [Trans. Vol. III, p. 632; Exhibit 522].
67. The Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing, defined the price for the gas sold by Cactus, and purchased by Enron Gas Marketing, as the applicable index price, as defined in the Hydrocarbon Exchange Agreement. [Trans. Vol. III, pp. 635-636; Trans. Vol. IV, pp. 716-718; Department Exhibit 522, pp. 000331, 000337].
68. The Hydrocarbon Purchase and Sale Agreement states that Index value has the meaning as defined in the Exchange Agreement. [Trans. Vol. IV, p. 718; Exhibit 522, p. 000331].
69. The term of the Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing, was consistent with the term of the production payment interest created between Cactus and Petitioner. [Trans. Vol. IV, pp. 644-645; Department Exhibit 522, p. 000341].
70. Pursuant to the Hydrocarbon Purchase and Sale Agreement between Cactus and Enron Gas Marketing, Enron Gas Marketing was not permitted to hold Cactus liable for Petitioners failure to perform under the VPP documents, but was required to pursue Petitioner directly for any failure of delivery of gas sold to Enron Gas Marketing. [Trans. Vol. IV, pp. 645-646; Department Exhibit 522, p. 000343].
71. The Department determined that the VPP gas transfer/exchange transaction between Cactus and Petitioner was a bona fide arms length transaction at the point of valuation in accordance with Wyoming Statute Section 39-2-208(c). [Trans. Vol. IV, p. 719; Joint Exhibits 302, 307, 314].
72. The Department determined that, pursuant to Wyoming Statute Section 39-2-208(c), Cactus arms length transfer of VPP gas to Petitioner in Wyoming was in exchange for identical volumes of MMBTUs at the four locations in Texas and Colorado, after which Cactus immediately sold the volumes in Texas and Colorado to Enron Gas Marketing. The Department concluded that the bona fide arms length value of the VPP gas was the value assigned by Cactus and Petitioner, that is, the index values received for the exchanged gas in Texas and Colorado. [Trans. Vol. IV, pp. 720, 737-738; Exhibits 302, 307, 314, 522].
73. The Department decided that the VPP gas should be valued pursuant to Wyoming Statute Section 39-2-208(c), which establishes that gas sold to a third party at or prior to the point of valuation is valued using the arms length value. [Trans. Vol. IV, pp. 657-658, 679, 709-711; Joint Exhibits 307, 314].
74. The Department concluded that the parties agreed in the Hydrocarbon Exchange Agreement that the Wyoming gas would be transferred from Cactus to Petitioner, and that the gas would be attributed a value established by the index prices at the four locations in Texas and Colorado. [Trans. Vol. IV, pp. 660-661, 709-713, 713-716; Joint Exhibit 302; Department Exhibits 521, 522].
75. The Department determined the bona fide arms length value of the VPP gas sold
by Cactus to Petitioner through the Exchange Agreement by applying the Departments rules. The Wyoming State Board of Equalization Rules, Chapter XXI, Section 4(l) (1991), and the Wyoming Department of Revenue Rules, Chapter 6, Section 4(l) define bona fide arms length sales. Bona fide arms length sales are valued in cash or terms equivalent to cash given for property. [Trans. Vol. IV, pp. 680, 737-738; Joint Exhibits 307, p. 00211; 319, p. 00316].
76. The Department, finding an arms length sale of the VPP gas between Cactus and Petitioner, considered the value placed upon the VPP gas by the parties to the Exchange Agreement and other agreements, which specified that the VPP gas would be valued at the index prices from four locations in Texas and Colorado. The agreed-upon index values were deemed terms equivalent to cash and reflected the consideration received by Cactus in exchange for the Wyoming VPP gas transferred to Petitioner. [Trans. Vol. IV, pp. 680-681; Exhibit 307].
77. By letter dated March 3, 1998, from Johnnie Burton, then Director of the Department of Revenue, to Steve Williams at Petitioner, the Department stated:
After much pondering about the impact and relevancy of the production payment from Cactus Hydrocarbon to Enron Oil and Gas on valuation of the gas covered by the volumetric production payment, we have come to the conclusion that Cactus was acquiring a real property interest in the reserves. The volume of gas covered by the transaction belongs to Cactus. The production payment, therefore, has no relevancy to the valuation of the gas when produced. Enron and Cactus own their respective shares of the gas separately.
[Stipulated Summary of Uncontested Facts, ¶7; Joint Exhibit 307].
78. The March 3, 1998 letter further provided:
Cactus is selling its gas to Enron in a bona fide arms length sale, but does not receive cash for it from Enron O&G. Instead, it agrees to terms equivalent to cash, i.e. gas in Colorado, and Texas. That gas is sold by Enron Gas Marketing and the cash is then remitted to Cactus. This represents the value of the gas sold to Enron Oil and Gas by Cactus at Big Piney. The audit will be conducted to gather this information, so that taxes can be assessed based on this value received by Cactus.
[Stipulated Summary of Uncontested Facts, ¶8; Joint Exhibit 307].
79. The DOA did not do a traditional audit, in that it did not examine how Petitioner had reported and paid taxes on the VPP during the audit period. [Trans. Vol. III, p. 509].
80. The DOAs audit finding was based on the legal conclusion set forth in Ms. Burtons March 3, 1998, letter that Cactus was making an arms length sale to Petitioner, and that Cactus proceeds under such sale, i.e., gas in Colorado, Louisiana and Texas, were the equivalent to cash. The DOA, as affirmed by the Department, calculated an additional increment of value on a well-by-well basis. The Department then used an average of the index prices at the four out-of-state delivery points and compared that price to the price reported by Petitioner for residue gas sold at Opal. The Department calculated a theoretical increment of value between the two prices for each well for each month and then summed all those increments by year to arrive at a value that the Department claims Petitioner under-reported for the year. The Department then applied interest to these year-by-year calculations to determine the amount assessed to Petitioner. [Trans. Vol. IV, p. 770; Trans. Vol. III, pp. 621-622].
81. Departments final assessment of Petitioners VPP gas was as follows:
Additional Severance Tax
Interest Through 3-1-2000
The total increase in ad valorem taxable value was $28,732,867, which was certified to Sublette and Lincoln Counties. The counties applied their respective mill levies against that taxable value to arrive at the ad valorem tax. They then assessed the difference. [Joint Exhibit 314].
What Was the Total Consideration for the VPP Transaction?
82. Cactus paid $326,775,000 for the VPP and delivered its associated volumetric share of production to Petitioner at delivery points in Wyoming. In return, Cactus received MMBTU equivalent quantities of gas at four out-of-state points in Colorado and Texas. Petitioner received the $326,775,000 from Cactus and also received Cactus volumetric share of production in Wyoming. In return, pursuant to the VPP documents, Petitioner was obligated at its cost to deliver volumes in Texas and Colorado, meet production requirements, make capital expenditures, satisfy operating and drilling requirements; and make certain reports. Petitioners obligations were secured with a mortgage and lien on Petitioners own share of production. [Trans. Vol. I, pp. 156-157; Petitioner Exhibit 145].
83. For the 33-month period prior to the time the VPP transaction was entered into, the value of gas at the wellhead in Wyoming averaged $0.55 per MMBTU less than the index values of gas at the four out-of-state delivery points in Colorado and Texas. [Trans. Vol. II, p. 333].
84. Cactus and Petitioner did not enter into the Hydrocarbon Exchange Agreement as a stand-alone transaction. [Trans. Vol. I, pp. 158-159]. Petitioners expert witness, John Harpole, stated that such a stand-alone transaction would have been a poor economic choice for the party receiving gas in Wyoming (in this case, Petitioner), because of the price differential between Wyoming and Texas. [Trans. Vol. II, pp. 335-336].
85. Petitioners Accounting Manager, Don Manton, who represented Petitioner in resolving tax disputes, did not request from the Department an interpretation of the tax statutes or a valuation determination concerning the VPP gas pursuant to Wyoming Statute Section 39-6-304. [Trans. Vol. III, p. 562].
86. Despite Mr. Mantons determination that no sale occurred at the wellhead, he admitted that he was not familiar with the Hydrocarbon Exchange Agreement between Cactus and Petitioner. [Trans. Vol. III, p. 574; Joint Exhibit 302]. He stated he did not have even a general understanding of what occurred under the Hydrocarbon Exchange Agreement. [Trans. Vol. III, p. 574-75; Joint Exhibit 302]. Nor was he aware that Cactus, under the Hydrocarbon Exchange Agreement, held full marketable title to the VPP gas produced in Wyoming. [Trans. Vol. III, p. 575; Joint Exhibit 302]. Mr. Manton also stated he did not know why, under the Hydrocarbon Exchange Agreement, Cactus transferred the VPP gas back to Petitioner. [Trans. Vol. III, p. 577; Joint Exhibit 302].
87. Mr. Manton, in determining that no sale occurred between Cactus and Petitioner at the wellhead, admitted that he knew little about the VPP documents and had not considered the relationship between Petitioner and Cactus or the facts and circumstances underlying the States valuation determination. [Trans. Vol., pp. 572-581].
88. Mr. Manton stated he did not have any idea what Cactus received for the gas Petitioner transferred to Cactus in Texas and Colorado. [Trans. Vol. III, pp. 580-581, 592-93].
89. There were times when the reported Opal tailgate price was actually higher than the average index prices at the four locations in Texas and Colorado. [Trans. Vol. III, p. 533].
90. No witness for Petitioner had any knowledge or would testify concerning what consideration Cactus received for the gas received in Texas and Colorado or, specifically, what price Cactus received for gas received and sold in Texas and Colorado pursuant to the Exchange Agreement. [Trans. Vol. IV, pp. 647-48].
91. Petitioner affirmatively declared that it had no information concerning what price Cactus received for gas delivered by Petitioner to Cactus in Texas and Colorado pursuant to the Exchange Agreement. [Trans. Vol. IV, pp. 648-50; Department Exhibit 520, pp. 000299-300, 000302].
92. Petitioners expert, Mr. Hugh Schaefer, stated that he believed that Cactus, by transferring the Wyoming gas to Petitioner and receiving in return gas in Texas and Colorado, knew it would receive a return on its investment of $326,775,000 by receiving gas at the higher values in Colorado and Texas. [Trans. Vol. II, p. 240].
The Interest Issue
93. The Department took a new position in the audit on the valuation methodology to be used to value the VPP production. In a previous audit, when the volumetric production payment issue was first uncovered, the Department verbally indicated that it might value the VPP gas by dividing the total MFC produced by $326,775,000. This position was never pursued because the parties agreed to set aside the VPP issue for the subsequent audit. [Joint Exhibit 307; Petitioner Exhibits 103, 104]. Prior to receiving the March 3, 1998 letter, Petitioner had no indication that the Department was going to take a position to value the VPP gas on the basis of the index prices at the four out-of-state delivery points. [Trans. Vol. III, p. 546].
94. During the entire time period, October 1992 through December 1996, Petitioner believed it was paying its taxes consistently with Wyoming law and the Departments requirements. [Trans. Vol. III, p. 545].
95. The Petitioner and its tax officials did not know, nor did they have any reason to know during the time the taxes were being paid, that the Department would take the position that it did regarding the effect of the exchange. The March 3, 1998 Burton letter was written after Petitioner had fully paid and reported all of its production. [Trans. Vol. III, p. 547].
CONCLUSIONS OF LAW
96. Petitioners notice of appeal was timely filed and the Board has jurisdiction to decide this matter.
Burden of Proof
97. Chapter 2, Section 19, of the State Board of Equalizations Rules and Regulations states in relevant part that:
Except as specifically provided by law or in this section, the Petitioner shall have the burden of going forward and the ultimate burden of persuasion, which burden shall be met by a preponderance of the evidence.
98. Petitioner has the burden of going forward and the ultimate burden of persuasion, to be met by a preponderance of the evidence that the Department of Revenues assessment was arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. Rules, Wyoming State Board of Equalization, Chapter 2 §19; Wyo. Stat. §16-3-114(c).
99. The burden of proof with respect to tax valuation is on the party asserting an improper valuation. Amoco Production Co. v. Wyoming State Board of Equalization, 899 P.2d 855 (Wyo. 1995).
100. An administrative agencys interpretation of statutory language in statutes which the agency normally implements is entitled to deference, unless clearly erroneous. Mowry v. State ex rel. Wyoming Retirement Board, 866 P.2d 729, 731 (Wyo. 1993); Laramie County Board of Equalization v. Wyoming State Board of Equalization, 915 P.2d 1184 (Wyo. 1996).
101. In reviewing a valuation method, the task is not to determine which of various appraisal methods is best or most accurately estimates fair market value; rather, it is to determine whether substantial evidence exists to support use of the chosen method. Amoco Production Co. v. Wyoming State Board of Equalization, 899 P.2d at 858.
102. The Departments valuation established for state-assessed property is presumed valid, accurate, and correct, a presumption which survives until overturned by credible evidence. In the absence of evidence to the contrary, it is presumed that the officials charged with establishing value, be it a county assessor or a Department appraiser, exercise honest judgment in accordance with the applicable statutes, rules, regulations, and other directives, which presumption survives until overturned by credible evidence. Chicago Burlington & Quincy Railroad Co. v. Brunch, 400 P.2d 494, 498-499 (Wyo. 1965).
103. A party challenging an assessment has the initial burden to present credible evidence to overcome the presumption. A mere difference of opinion as to value is not sufficient. Teton Valley Ranch v. State Board of Equalization, 735 P.2d 107 (Wyo. 1987); Hillard v. Big Horn Coal Co., 549 P. 293 (Wyo. 1976); Weaver v. State Board of Equalization, 511 P.2d 97 (Wyo. 1973); CF&I Steel Corp. v. State Board of Equalization, 492 P.2d 529 (Wyo. 1972); Chicago Burlington & Quincy Railroad v. Bruch, 400 P.2d 494 (Wyo. 1965); J. Ray McDermott & Co. v. Hudson, 370 P.2d 363 (Wyo. 1962); Certain-Teed Products Corp. v. Comily, 87 P.2d 21 (Wyo. 1939).
104. The tax valuation issues in this case are governed by Wyoming Statute Section 39-2-208, which in part provides as follows:
Valuation of oil and gas.
(a) Crude oil, lease condensate and natural gas shall be valued for taxation as provided in this section.
(b) The mining or production process is completed:
(ii) For natural gas, after extracting from the well, gathering, separating, injecting and any other activity which occurs before the outlet of the initial dehydrator. When no dehydration is performed, other than within a processing facility, the production process is completed at the inlet to the initial transportation related compressor, custody transfer meter or processing facility, whichever occurs first.
(c) If the products defined in subsection (b) of this section are sold to a third party, or processed or transported by a third party at or prior to the point of valuation provided in subsection (b) of this section, the fair cash market value shall be the value established by bona fide arms-length transaction.
105. Mineral taxpayers are required to report their tax liability to the Department pursuant to a self-reporting tax system which requires that taxpayers report their tax liability to the Department. Wyo. Stat §39-6-304(a). [Trans. Vol. IV, p. 705]. Wyoming Statute Section 39-2-202(a) provides that based on information received from the reporting taxpayer, the Department shall annually value the gross product for the preceding calendar year.
106. The Department is required to [d]ecide all questions that may arise with reference to the construction of any statute affecting the assessment, levy and collection of taxes, in accordance with the rules, regulations and orders and instructions prescribed by the department. Wyo. Stat. § 39-1-303(a)(xxv) (recodified as Wyo. Stat. § 39-11-102(c)(xii)).
There was a Sale or Exchange of the VPP Gas Between Cactus and EOG.
107. The Department concluded that upon production Cactus sold the oil and gas to Petitioner in an arms length arrangement and that the consideration for this sale was the delivery of gas to Cactus at designated delivery points in Colorado and Texas. The Department further decided that the consideration for the Wyoming gas should be determined by the index price for which gas traded at the four delivery points in Colorado and Texas. The Department valued this arms length sale pursuant to Wyoming Statute Section 39-2-208(c). Petitioner argues that there was no arms length sale at the point of valuation, that the delivery of gas, oil and condensate from Cactus to Petitioner was not a sale, but simply one part of the larger set of obligations undertaken by Petitioner as a result of entering into the VPP. Petitioner contends the VPP was a complex financing transaction in which the exchange of the Wyoming production for the gas in Colorado and Texas was the last step in the repayment obligations that Petitioner undertook in the VPP. Petitioner maintains that because there was no arms length sale at the point of valuation, Cactus share of production was properly valued under Wyoming Statute Section 39-2-208(d).
108. The issue of valuing gas which is subject to a volumetric production payment is a case of first impression for the Board. There can be little doubt that the VPP is an exceedingly complex transaction, one which the drafters of the mineral tax valuation statutes would not have anticipated. Petitioner did an excellent job of educating the Board on the construction and intricacies of volumetric production payments, and the Department assisted by dissecting the crucial provisions of the transactions as they relate to the valuation statutes.
109. There was no evidence to suggest that the VPP was created to avoid the payment of state severance and ad valorem taxes or to shelter additional consideration from taxation. Rather we believe that the VPP was created expressly for the purpose of raising capital to finance the acquisition, exploration and development of Petitioners oil and gas properties. Because conventional financing was not available, Petitioner utilized production payment financing; that is, they sold a real property interest in the oil and gas leases to a consortium of banks for a limited period of time in exchange for $326,775,000. The VPP transactions were constructed in such a way as to protect the purchasers of the production payment from any potential creditors in bankruptcy of the seller.
110. Having stated that we believe the primary purpose for the creation of the VPP was a financing device, we are nevertheless unable to agree with Petitioners argument that the delivery by Cactus of the VPP gas to Petitioner at the delivery point in Wyoming was merely an exchange in fulfilment of one of the many contractual provisions of the VPP.
111. Sale is defined as:
A contract between two parties, called, respectively, the seller (or vendor) and the buyer (or purchaser), by which the former, in consideration of the payment or promise of payment of a certain price in money, transfers to the latter the title and the possession of property. Transfer of property as providing of services for consideration. A transfer of property for a fixed price in money or its equivalent. * * *
The term comprehends transfer of property from one party to another for valuable recompense. * * *
To constitute a sale, there must be parties standing to each other in the relation of buyer and seller, their minds must assent to the same proposition, and a consideration must pass.
Blacks Law Dictionary, p. 1337 (6th Ed. 1990).
112. Wyoming Statute Section 34.1-2-106(a), defines the term sale in the Uniform Commercial Code, as requiring a passing of title from the seller to the buyer for a price. See also Wyo. Stat. § 34.1-2-401 (describing the characteristics of a sale).
113. Fair market value is defined as the amount in cash, or terms reasonably equivalent to cash, a well informed buyer is justified in paying for a property and a well informed seller is justified in accepting, assuming neither party to the transaction is acting under undue compulsion, and assuming the property has been offered in the open market for a reasonable time, . . . Wyo. Stat. § 39-1-101(a)(vi).
114. The Boards rules in effect at the time of the VPP transaction defined bona fide arms-length sale as a transaction in cash or terms equivalent to cash for specified property rights after reasonable exposure in a competitive market between a willing, well informed and prudent buyer and seller with adverse economic interests and assuming neither party is acting under undue compulsion or duress. Rules, Wyoming State Board of Equalization, Chapter 21 § 4(l) (1991).
115. 77 Am. Jur. 2d Vendor and Purchaser § 1 (1997) states:
[A]sale is a transfer of real property for a fixed value, that is, for a price in money or its equivalent, while an exchange is a transfer of property for other property of value. In this regard, a transaction is a sale, even though made for something other than money, where the property of one party is transferred for that of the other at an agreed or market value, so that one thing is received in payment of the price of the other, or where the property of one party is transferred as actual part payment in price or value for the price placed on the property of the other. (Emphasis added).
116. [T]he test for determining whether a transaction constitutes a sale or an exchange is whether there is a fixed value at which the exchange is to be made - it is considered a sale if there is a fixed value and an exchange if there is not. Fain Land & Cattle Co. v. Hassell, 790 P.2d 242, 247 (Ariz. 1990), citing Hawn v. Malone, 188 Iowa 439, 176 N.W. 393, 396 (1920) (Emphasis added).
It is no distortion of language to employ the term sale so as to cover or include an exchange of property. The courts in certain decisions have made an effort to define each term with precision and it has been held that the criterion in determining whether a transaction is a sale or exchange is whether there is a determination of the value of the things exchanged. If no price is set for either property, it is said to be an exchange; but if each is valued and the difference is paid in money, it is a sale.
Gruver v. CIR, 142 F.2d 363, 3365-66 (4th Cir. 1994); See also Gill et al. v. Eagelton, 187 N.W. 871, 872-873 (Neb. 1922) (A transaction is a sale where properties are exchanged and the consideration or value of the bargain is specified and measured in money terms).
117. The Department was correct in concluding that a sale, not an exchange, took place between Cactus and Petitioner at the point of valuation in Wyoming. The consideration or the value of the bargain at the point of valuation in Wyoming was an equivalent amount of gas, measured in MMBTUs, delivered to Cactus at specified delivery points in Colorado and Texas, and the value of that gas was to be the index prices established in Colorado and Texas. This value was clearly established in the Hydrocarbon Exchange Agreement and in the Hydrocarbon Purchase and Sale Agreement. Thus the parties specifically agreed upon the value of the properties to be exchanged, consistent with a sale rather than a simple exchange. [Trans. Vol. IV, pp. 714-717; Joint Exhibit 302, pp. 00086, 00101].
118. The fact that the VPP was a volumetric production payment rather than a dollar denominated production payment does not create a relevant distinction between an exchange and a sale. The parties specifically agreed upon a value for the gas, that being the index prices in Colorado and Texas. One of the parties to the VPP documents, Cactus Hydrocarbon, which owned legal title to the VPP gas, was ultimately the entity which owed severance and ad valorem tax to the State. EOG, under the terms of the VPP documents, assumed the responsibility for reporting and paying the taxes on behalf of Cactus. Unfortunately, Cactus, one of the parties to the transactions in question, was conspicuously absent in the contested case before this Board and thus was unable to testify as to what consideration it bargained for at the time it entered into the VPP transactions. The Board is therefore left to surmise the intentions of Cactus when it entered into the VPP transaction. However, all of the evidence in the record suggests that Cactus, a consortium of banks, was very sophisticated and knowledgeable about the natural gas industry and obviously was aware of the significant differences in gas prices at the various market centers. As Judy Matlock, Attorney for Petitioner, stated:
Mr. Chairman, the reason that we are presenting this [EOG Exhibit 124] is to show what the parties knew or probably should have known about the relative difference between what Cactus was going to give to EOG in Wyoming and what EOG was going to give to Cactus at the four out-of-state points. This type of information would have been available to them in making a decision about whether to enter into the purchase and sale agreement and related transactions.
[Trans. Vol. II, p. 334]
John Harpole, Petitioners expert witness on gas marketing, presented an exhibit which demonstrated that there was a $0.55 average price differential between Opal and the four indices in Colorado and Texas. [Petitioner Exhibit 124]. In response to questions by the Board regarding the differences in gas prices at Opal verses market centers in Texas, Mr. Harpole testified:
Every time you trade a forward price in the Rockies, you also trade a basis differential. You dont get that NYMEX price because you decide to go on the NYMEX exchange. You get a discount to the NYMEX price in Wyoming, in Colorado and Utah. . . .
We know that our gas isnt worth as much simply because were not located [next] to commercial, residential and industrial demand.
[Trans. Vol. II, pp. 350-351].
119. The Board agrees with the Department that Cactus, holding marketable title to the VPP gas in Wyoming, had the right and ability to do anything it desired with that gas. Cactus was aware that gas sold in markets in Colorado and Texas had a substantially higher value than gas sold at Opal, so Cactus bargained for and received a value for the gas to be exchanged which was specifically tied to the index prices in Colorado and Texas. The negotiation for a specific index price is consistent with a sale rather than a simple exchange.
120. Petitioner devoted a great deal of time and effort, through the testimony of its experts, to demonstrate how the four VPP documents were inextricably linked and related as a financing transaction and the delivery of gas from EOG to Cactus in Wyoming was a disposition of lease production. However, the Department, during its trip to Petitioners offices in Houston, discovered a fifth agreement, the Hydrocarbon Purchase and Sale Agreement dated September 28, 1992, between Cactus Hydrocarbons and Enron Gas Marketing. This is not to imply that Petitioner attempted to hide this document from the Department, because it did provide the document, but clearly Petitioner has attempted to minimize its importance. Petitioners witnesses professed ignorance about its contents, presumably because Petitioners marketing affiliate, Enron Gas Marketing, was a party to that agreement, not EOG. Yet, virtually every provision of this September 28th agreement referenced the original four VPP documents and the Board sees no legitimate reason to draw a distinction between EOG and Enron Gas Marketing. Enron Gas Marketing was the marketing affiliate for EOG and without its marketing affiliates ability to deliver an equivalent amount of gas to Cactus at the delivery points in Colorado and Texas, EOG could not have performed one of the primary considerations of the VPP documents.
121. The Board concludes that the Department was correct in declining to read into Wyoming Statute Section 39-2-208(c) an exception for taxpayers who transfer and sell property pursuant to a purported financing transaction. If language of statute is clear and unambiguous, court must abide by its plain meaning. Amrein v. State, 836 P.2d 862, 864 (Wyo. 1992). Parties are bound by the plainly stated terms of a contract. Emmett Ranch, Inc. v. Goldmark Engineering, Inc. 908 P.2d 941, 945 (Wyo. 1995). Courts may not rewrite a clear and unambiguous contract under the pretext of interpretation. Synder v. Lovercheck, 992 P.2d 1079, 1089 (Wyo. 1999). Regardless of how complicated and sophisticated the VPP transaction appears upon first reading, the intention of the parties was not hidden. Cactus entered into the contracts for the express purpose of making a substantial profit by selling the gas delivered to it by EOG at the delivery points in Colorado and Texas. Cactus clearly understood that the value of gas was significantly higher at the index prices in Colorado and Texas than in Wyoming. That is what Cactus bargained for when it entered into the agreements to purchase the real property interest in gas in the ground. EOG, in order to entice Cactus into purchasing the production payment, purposely and deliberately crafted the VPP documents in such a way as to ensure that the production payment would not be construed as a mortgage.
Although properly drafted production payments should be excluded from the bankruptcy estate of an operator/debtor, care must be taken to ensure that the production payment cannot be characterized as a mortgage, thereby reducing its owner to just another creditor in the operators bankruptcy proceeding.
39 Rocky Mt. Mineral Law Inst. §16.04 (1993). See also [Joint Exhibits 300, 301, 302, 304].
There is no reference to mortgagor, mortgagee, borrower, borrowee, lender, loan, mortgage, collateral or debt within the body of the VPP documents. But there are references to buyer and seller, grantor and grantee, all language that is consistent with a sales transaction.
The First Sale of the VPP Gas Occurred at the Custody Transfer Meters in Wyoming.
122. The Board also rejects any notion that Cactus did not have full marketable title and right to possession of the VPP gas in place when it sold the gas to EOG. In order to provide Cactus with full protection from liability in any potential bankruptcy of EOG, it was necessary for Cactus to have total ownership of the VPP gas so that the production payment could not be construed as a mortgage. It would be disingenuous to suggest that Cactus had full marketable title for purposes of claiming protection from potential bankruptcy while disavowing Cactus ownership in order to claim that no sale had occurred between Cactus and EOG for state tax purposes.
123. The Board holds that the first sale of the produced VPP gas in Wyoming occurred at the point of valuation (custody transfer meters). The Department was correct in determining that the VPP gas should be valued pursuant to Wyoming Statute Section 39-2-208(b), which provides, Crude oil, lease condensate and natural gas shall be valued for taxation as provided in this section, and Wyoming Statute Section 39-2-208(c) which provides; If the products defined in subsection (b) of this section are sold to a third party, or processed or transported by a third party at or prior to the point of valuation provided in subsection (b) of this section, the fair cash market value shall be the value established by bona fide arms-length transaction.
The Parties to the VPP Transactions Bargained For Index Prices in Colorado and Texas.
124. The Department, in accordance with its statutory authority, properly considered all of the contracts between Cactus and EOG, and between Cactus and Enron Gas Marketing, to determine that Cactus and EOG mutually agreed and bargained that Cactus would receive an index price for transfer and sale of the Wyoming VPP gas through the exchange with EOG. Hillard v. Big Horn Coal Company, 549 P.2d at 298-299 (Department must consider all factors which relate to value). See also [Trans. Vol. IV, pp. 660-661, 709-713]. The basic elements of a contract are offer, acceptance, and consideration. Boone v. Frontier Refining, Inc. 987 P.2d 681, 687 (Wyo. 1999). A generally accepted definition of consideration is that a legal detriment has been bargained for and exchanged for a promise. Loghry v. Unicover Corp., 927 P.2d 706, 712 (Wyo. 1996) citing Moorcroft State Bank v. Morel, 701 P.2d 1159, 1161-1162 (Wyo. 1985). There can be no question that Cactus agreed to transfer and sell the VPP gas to EOG in Wyoming in exchange for an equivalent amount of MMBTUs delivered to Cactus at four points in Texas and Colorado. If Cactus had not been contemplating receiving the higher index prices in Texas and Colorado, there would have been no reason to contractually provide for delivery at those specified points. In interpreting a contract, courts primary concern is the true intent and understanding of the parties at the time and place the contract was made. Fremont Homes, Inc. v. Elmer, 974 P.2d 952, 956 (Wyo. 1999).
The Department Did Not Violate the Uniformity of Assessment Requirement of the Wyoming Constitution by Valuing the VPP Gas Differently from the Value of the Non-VPP Gas Sold by EOG at Opal.
125. The Wyoming Supreme Court, discussing the fair and uniform valuation of property, has explained:
In performing its constitutional and statutory functions the Board may arrive at different valuations for different property, but the method or system used by the Board must lead to a fair value, and the properties must be assessed at a uniform rate.
Scott Realty Co. v. State Board of Equalization, 395 P2d 289 (Wyo. 1964).
The fact that all of the gas was produced from the same wells does not require that the gas be valued precisely the same. The VPP gas was owned by Cactus, not EOG, and was sold under different circumstances for different mutually agreed-upon consideration. Neither due process nor equal protection imposes upon the Department any rigid rule of identical valuation. Severance taxes and ad valorem taxes are based upon the gross receipts received for the product. Therefore it is not uncommon for different producers to receive different consideration for their mineral products based upon their ability to negotiate a good price in the marketplace. All that is required is that a uniform rate of taxation be applied to the value received.
The Audit Conducted by DOA Was Not Flawed.
126. Petitioner argued that the audit was somehow flawed because the auditors did not compare EOGs actual reporting and payment of taxes and instead only computed a difference between the value based on index prices in Colorado and Texas and the Opal index prices. The DOA announced its intention from the beginning to audit the VPP gas production which had been identified and set aside as a potential problem in the prior audit. The auditor took painstaking care to isolate the VPP gas production from EOGs non-VPP gas production and took into account any adjustments for taxes and exempt royalties. The Board believes the auditing technique used by the DOA was a reasonable approach, particularly when the company was given an opportunity during the course of the audit to raise objections. Similarly unpersuasive is Petitioners argument that the DOA failed to determine how EOGs ultimate tax liability would be affected by considering the amounts that EOG paid for taxes on oil, condensate and natural gas liquids (NGLs). The DOA specifically asked EOG to provide information concerning the NGLs in the audit engagement letter. EOGs Accounting Director never objected to the DOAs treatment of the NGLs when he responded to the DOAs preliminary issue letter. His failure to do so then, and to now, raise the issue on appeal is untimely. A partys failure to object or assert known claims may constitute waiver or give rise to an estoppel defense. Dawson, Corbett & Shelp v. Lierance & Canfield Construction Co., 235 P.2d 457, 463 (Wyo. 1951). In any event, the DOA accepted the values for oil, condensate and NGLs reported by Petitioner as they were sold at Opal.
The Department Did Not Correctly Calculate The Interest.
127. The Board agrees with Petitioner that EOG did not know nor did it have any reason to know at the time it was reporting and paying its taxes that the Department would apply the valuation theory set forth in Director Burtons March 3, 1998, letter. This is particularly true because the Department initially indicated that it might value the VPP gas using a different method than was ultimately chosen. We do not believe it is reasonable to impose interest on Petitioner for the time period prior to the March 3, 1998, letter because of the uncertainty of the Departments position. Interest should be imposed only from March 3, 1998, forward.
The Boards Ruling Denying Petitioner the Opportunity to Present Evidence on the Presence of Dehydrators and the Proper Point of Valuation Was Correct.
128. On the second day of the hearing the Board heard arguments of counsel regarding Petitioners position that the Department had used the wrong point of valuation in its audit. Petitioner asked the Board to rule that it be permitted to introduce evidence and make a legal argument concerning the point of valuation. Petitioners argument was that Wyoming Statute Section 39-2-208(b)(ii) sets the point of valuation for natural gas at the initial dehydrator. The point at which the gas transfers from Cactus to EOG was at the custody transfer meter. Because the meter is downstream of the point of valuation, that being the dehydrator, there is a technical statutory argument that the point of valuation at the outlet of the dehydrator is the proper point of valuation, not the meter which the Department used. According to Petitioner, because it believes the first arms length sale occurred downstream from the outlet of the initial dehydrator, i.e., at the Opal plant, the Department was required to select one of the four valuation methodologies listed in Wyoming Statute Section 39-2-208(d) which included comparable sales and comparable value. The Board heard the arguments of counsel, reserved ruling at that time, and then issued its oral decision on October 25, 2001, near the end of the hearing, denying Petitioners legal argument on the point of valuation theory. The Board allowed the parties to file written briefs on this issue and to submit them along with their Proposed Findings of Fact and Conclusions of Law.
129. Despite the fact that the Board withheld its ruling on Petitioners motion until late in the hearing, there was, in fact, evidence introduced regarding the point of valuation. Although none of Petitioners witnesses could detail or testify with any certainty as to the configuration of the nearly 1000 wells that were in the field, there was testimony that some had combo units (orifice meter and dehydrator located within the same small building), and some did not. The Board also accepted the testimony of Petitioners expert witness, Doug Weaver, Vice-President and General Manager, who testified that in December of 1996, at the end of the audit period, approximately 880 of the approximately 970 wells at issue in this case were equipped with dehydrators. [Trans. Vol. IV, p. 784].
130. As a general rule, most of the VPP wells were configured similar to the well depicted in Petitioners Exhibits 109, pages 42, 42a, 42b, 43 and 43a. These Exhibits depict a combo unit which is essentially a small metal building housing the dehydrator and the orifice meter which in turn was connected to a custody transfer meter attached to the outside of the building. The distance between the dehydrator and the custody transfer meter was rarely more than a few feet in distance. The combo unit is designed primarily to protect the dehydrator and meter from the extreme winter conditions in the Big Piney field. Petitioners Exhibit 141 is a schematic diagram of how the typical natural gas well site was configured. Petitioners Exhibit 109, p. 43a, is a photograph of a well site which gives one a perspective of the distances between the well bore, production tanks, separator, combo unit and the sales line. Based on the testimony in the hearing, the Board concluded that these Exhibits were representative of the typical gas well in the Big Piney field.
131. In its Motion for Reconsideration, Petitioner indulged in a hyper-technical argument that if the Departments position was correct that a arms length sale took place at the custody transfer meter under the VPP documents, then the Department should have used an alternative valuation method under the statute because technically the gas was sold a few feet away from the outlet of the dehydrator which is downstream from the statutory point of valuation. The Board finds this argument to be both breathtakingly ingenious and nonsensical at the same time. The reason why the Wyoming Legislature deemed it necessary to establish a point of valuation was because it was important to separate upstream production costs from downstream transportation costs, the latter being deductible from the gross value received by the producer at the wellhead. Many times this becomes important in gas fields where the wellheads, dehydrators and custody transfer meters are located miles apart. When the custody transfer meter and the outlet of the dehydrator are located virtually side-by-side as they are in this case, the distance is of no significance whatsoever. The Board found Petitioners argument to be irrelevant at the hearing and after further reviewing the record, we find it to be irrelevant still.
132. The Board also finds that Petitioners motion to be prejudicial to the Department because of unfair surprise, and due to Petitioners failure to raise and plead this issue on any number of occasions during the course of the audit. During the nearly two years of the audit, Petitioner never raised an issue with the DOA or Department about the existence of dehydrators and any possible legal significance that might have as to the point of valuation. Petitioner became aware of the Departments valuation decision on March 3, 1998, when it received the Burton letter. Petitioner did not raise the issue in its Notice of Appeal filed on January 16, 2001, nor did it raise the issue during discovery. The Stipulated Updated Summary of Uncontested Facts, signed by both parties on October 15, 2001, states in Paragraph 5 that: Title to the production attributable to Cactus ownership of the VPP passed to EOG at field custody transfer meters in Wyoming pursuant to the Hydrocarbon Exchange Agreement. (emphasis provided).
134. One week before the hearing began on October 22, 2001, Petitioner served its Updated Summary of Contentions upon the Department. This appears to be the first clear reference to the presence of dehydrators at the well sites and Petitioners new, alternative theory. Petitioner failed to provide the Department any reasonable or timely notice that it intended to raise a point of valuation issue and in fact, appeared to endorse the notion that the custody transfer meters were the proper point of valuation. To allow Petitioners argument to be admitted at the eleventh hour would be unduly prejudicial to the Department since the Department would have had virtually no time in which to investigate which wells may or may not have had dehydrators. Furthermore, making such determination many years after the time of the production, and of the audit, might will be proved impossible, Finally, the Boards rules do not allow motions to be filed within twenty (20) days of a hearing. Rules, State Board of Equalization, Chapter 2, §12(a), Chapter 2 §11 (October 20, 1995), Chapter 2 §13 (February 1990).
IT IS THEREFORE HEREBY ORDERED:
A. The decision of the Department of Revenue assessing EOG Resources, Inc. for a production tax audit conducted by the Department of Audit for production years 1992 through 1996 is affirmed.
B. The decision of the Department of Revenue that a bona fide arms length sale of natural gas occurred between Cactus Hydrocarbons and EOG at the custody transfer meters of the wells located in Wyoming is affirmed.
C. The decision of the Department of Revenue to value the sale of the VPP natural gas using the average of index prices of four specified delivery points in Colorado and Texas is affirmed.
D. The decision of the Department of Revenue to assess interest against Petitioner from the dates that the natural gas was produced until the present is reversed and the case is remanded to the Department for recalculation of the interest assessment based on the tax deficiency from March 3, 1998 to the present.
DATED this 25th day of June, 2002.
STATE BOARD OF EQUALIZATION
Edmund J. Schmidt, Chairman
Roberta A. Coates, Vice Chairman
Sylvia Lee Hackl, Member
Wendy J. Soto, Executive Secretary