BEFORE THE STATE BOARD OF EQUALIZATION

FOR THE STATE OF WYOMING

IN THE MATTER OF THE APPEAL OF                            ) 

BURLINGTON RESOURCES OIL & GAS CO.,         )

FROM A NOTICE OF VALUATION FOR                        )         Docket No. 2006-65

TAXATION PURPOSES BY THE MINERAL                  ) 

DIVISION OF THE DEPARTMENT OF REVENUE        )

(Madden Deep Field/Lost Cabin Plant 2005 Prod. Yr.)   )

FINDINGS OF FACT, CONCLUSIONS OF LAW, DECISION AND ORDER

APPEARANCES

Lawrence J. Wolfe, Patrick R. Day, Walter F. Eggers III, and Rachel Ann Yates of Holland & Hart, LLP, for Burlington Resources Oil & Gas Co. (Burlington or Petitioner).

Karl D. Anderson, Senior Assistant Attorney General, for the Department of Revenue. (Department)

JURISDICTION

Burlington, in the spring of 2006, filed annual gross products returns with the Department related to its 2005 natural gas production processed through the Lost Cabin Gas Plant (Lost Cabin). Burlington reported its taxable value using the proportionate profits method in two separate calculations. One calculation included taxes and royalties as direct costs of production; the second excluded both from direct costs. The Department did not accept Burlington’s reported values. The Department instead valued Burlington’s 2005 production using the comparable value method as indicated in its Notice of Valuation dated May 5, 2006. Burlington, on June 5, 2006, filed a timely appeal with the State Board of Equalization (Board) from the Department’s taxable value determination pursuant to Wyo. Stat. Ann. §§ 39-14-209(b), 39-13-102(n), and Rules, Wyoming State Board of Equalization, Chapter 2, § 5(a). The Board may hear objections to the Department’s determination of the fair market value of natural gas production, and accordingly has jurisdiction to consider this appeal.

A hearing was held January 23 through January 25, 2007, before the Board, consisting of Alan B. Minier, Chairman, Thomas R. Satterfield, Vice Chairman , and Thomas D. Roberts, Board Member.

STATEMENT OF THE CASE

This appeal concerns a change in valuation methods utilized by the Department to value 2005 gas production from the Madden Deep Field processed at Lost Cabin, Mineral Group 15123. The Department issued a Notice of Valuation for Tax Purposes (NOV) on April 17, 2006, using the proportionate profits method with inclusion of production taxes and royalties as direct costs of producing in the direct cost ratio. The Department thereafter, on May 5, 2006, issued a second NOV valuing Burlington’s gas production processed at Lost Cabin utilizing the comparable value method. Burlington filed a Notice of Appeal on June 5, 2006, challenging the NOV dated May 5, 2006, asserting the comparable value methodology is not applicable to value gas processed at Lost Cabin. We agree, and reverse the Department’s May 5, 2006, determination of value.

CONTENTIONS AND ISSUES

In prehearing pleadings, Burlington identified seven contested issues of fact and nine contested issues of law pertaining to natural gas production processed at Lost Cabin. Burlington stated the issues of fact as:

A.    Did the Department follow the notification procedures of Wyo. Stat. 39-14-203(b)(vi) to notify Burlington of the new valuation methodology by September 1, 2004?

B.    Did the Department follow the valuation selection procedures required by Wyo. Stat. 39-14-203(b)?

C.    Are there any comparable processing agreements that can be used for the comparable value methodology, assuming the Department can change valuation methods?

D.    Did the Department correctly use the comparable value methodology to value Burlington’s 2005 production from the Madden Field which is processed at the Lost Cabin Gas Plant?

E.    If the Department is correct in its use of the comparable value methodology, what contracts and/or agreements were used for the comparison; does the use of those contracts allow Burlington to recover all of its processing and transportation costs; and does it result in fair market value?

F.    Have any of the facts or circumstances concerning the Lost Cabin Gas Plant Construction and Operating Agreement (“C&O Agreement”) changed since the Department made its original decision that the C&O Agreement was not a valid “comparable” agreement?

G.    Would the assessment of interest by the Department be proper?

[Petitioner Burlington Resources Oil & Gas Company LP’s Issues of Fact and Law and Exhibit Index, pp. 1-2].

Burlington stated its issues of law as follows:

A.    Did the Department have authority to change the 2005 valuation method for Madden Deep gas without Burlington’s agreement?

B.    Whether the Department’s NOV is void because the Department failed to give advance notice by September 1, 2004, of its intention to change valuation methods?

C.    Whether the Department’s NOV is void because it violated Wyo. Stat. 39-14-203(b)(iii) when it failed to notify Burlington to use the comparable value method in the three-year valuation cycle and instead told Burlington to use the proportionate profits method?

D.    Whether the Department’s NOV should be reversed because the Department failed to inform Burlington of the allegedly comparable processing agreements that it used to establish the value announced in the NOV?

E.    Whether the Department’s comparable value method taxes value added by processing and transportation, fails to allow Burlington to recover all of its costs of processing and transportation, and fails to result in fair market value?

F.    Whether the Department’s use of the comparable value methodology is contrary to Wyoming’s tax statutes, Wyoming case law, and the Department’s Rules?

G.    Is the Department’s purported comparable value method used in the NOV actually a netback method, Wyo. Stat. 39-14-203(b)(vi)(C)?

H.    Did the Department properly treat all operational costs associated with gas processing?

I.    Burlington hereby adopts all legal arguments regarding the Department’s erroneous inclusion of taxes and royalties in the direct cost ratio as direct costs of producing that it has made before the Board and the Wyoming Supreme Court in the cases currently pending before the Supreme Court.

[Petitioner Burlington Resources Oil & Gas Company LP’s Issues of Fact and Law and Exhibit Index, p. 2].

The Department identified a single mixed question of fact and law:

Did the Department correctly and properly use the “Comparable Value” method, as set forth in Wyo. Stat. § 39-14-203(b)(vi)(B), to value Petitioner’s 2005 mineral production?

[Department of Revenue’s Updated Issues of Fact, Issues of Law and Exhibit List, pp. 1-2].

Following BP America Production Co. et al. v. Department of Revenue, 2005 WY 60, 112 P.3d 596 (Wyo. 2005), we restate the issues to a single mixed question of fact and law:

When the Department applied the comparable value method of valuation, as set forth in Wyo. Stat. Ann. § 39-14-203(b)(vi)(B), to value natural gas produced by Burlington for production year 2005, did it find reliable information about processing fees paid by other taxpayers in similar situations, and make reasonable inferences as to Burlington’s processing costs for its 2005 production?

FINDINGS OF FACT

1.        Jack D. Morrow testified on behalf of Burlington. Morrow worked for Louisiana Land & Exploration (LL&E), and subsequently Burlington, from 1975 until his retirement on May 31, 2000. Morrow, during his career, worked as a staff engineer, engineering supervisor, production manager, district manager, and area asset manager, and worked on issues involving Lost Cabin. Burlington purchased LL&E in 1997. [Transcript Vol. I, pp. 65-66; Vol. II, p. 372.]

2.        Lost Cabin is located in Fremont County near the Natrona County border. The original plant came online in March, 1995. [Transcript Vol. I, pp. 66-67, 159; Vol. II, p. 373; Exhibit 105].

3.        Lost Cabin processes gas from the Madden Deep Unit (Madden Deep) as created in 1967. The Fort Union, Lance, Mesa Verde, and Cody formations were developed by producing wells between 1968 and 1983. The gas produced from these formations requires no processing to meet pipeline specifications other than regular oil field processing to remove excess water and cool the gas to the proper pipeline temperature. [Transcript Vol. I, pp. 68-69; Exhibit 107].

4.        Development of the Madden Deep changed significantly when Monsanto drilled the Big Horn 1-5 well into the Madison Formation in 1983. The well, when tested in 1985, revealed a significant gas pay. The gas, however, was extremely sour with a composition of 12 percent H2S, 20 percent CO2, 67 percent methane, 1 percent “other,” and a bottom hole temperature in excess of 400 degrees Fahrenheit, which is extremely high. Most gas enters a processing plant at 100 degrees Fahrenheit. The high concentration of H2S rendered the gas extremely dangerous and deadly. It was unlike any gas in Wyoming, and possibly in the world other than some gas wells in Indonesia. The gas must be processed in order to meet pipeline specifications. [Transcript Vol. I, pp. 69-72; Vol. II, p.274; Exhibit 108].

5.         The Big Horn 1-5 was tested for a relatively short time in recognition of the amount of hydrogen sulfide pollution released during the test flaring. The well was then “pickled,” that is, filled with corrosion inhibitor and shut in. [Transcript Vol. I, pp. 72-75; Exhibit 106].

6.        A second well, the Big Horn 2-3, was drilled into the Madison Formation during 1987 and 1988. The characteristics of the gas from this well were exactly the same as encountered in the Big Horn 1-5 well, i.e., 67 percent methane, 12 percent H2S, and 20 percent CO2. This well was also tested and then pickled. [Transcript Vol. I, pp. 72-75; Exhibit 106].

7.        After completion of the Big Horn 2-3, BHP became field operator, having purchased the interest of Monsanto. BHP and the other working interest owners began the design process to determine what would be required to process this sour gas and place it for sale into a pipeline. BHP resigned as operator in 1990, and LL&E was elected as successor operator. [Transcript Vol. I, p. 75].

8.        LL&E continued the effort to find a way to process the Madison Formation gas. The effort included all the working interest owners as the intent of LL&E was to keep well ownership and processing plant ownership as close to the same as possible. All working interest owners would thus be required to agree to build the plant and be charged for its cost. [Transcript Vol. I, p. 76].

9.        LL&E initiated the design process and development of a Construction and Operating Agreement (C&O Agreement) for the plant. The first working draft of the C&O Agreement was sent to all working interest owners in early 1991. The draft was sent to solicit input from, and for discussion during a meeting with, the working interest owners. The draft was not sent seeking working interest approval. [Transcript Vol. I, pp. 76-79, 82-83; Confidential Exhibit 913].

10.      This initial working draft C&O Agreement contemplated LL&E as plant operator. The Agreement also contained paragraphs indicating the intent of the working interest owners to not be considered a partnership. From the beginning, the intent of the C&O Agreement, according to Morrow, was to keep ownership consistent from the reserves in the ground to ownership in the wells, to ownership of the processing plant. The owners desired to maintain their status as individual owners, and not be grouped collectively as a partnership. [Transcript Vol. I, pp. 84-85, 89; Confidential Exhibit 913, p. 133].

11.      The initial working draft C&O Agreement designated LL&E as the gas processor with the producers being everyone who signed the Agreement in anticipation of moving their gas through the plant. The draft C&O Agreement provided a fee structure for payment for processing services. [Transcript Vol. I, pp. 88-94 (pp. 92-94 Confidential); Confidential Exhibit 913, pp. 172, 180, 196, 221].

12.      A second working draft C&O Agreement was circulated on May 8, 1991. This draft, in addition to the processing fee for plant owner dedicated gas, also contained a provision for processing, for a defined fee, “plant supplier gas,” being gas processed for a nonplant owner. The nonplant owner would be required to execute a separate processing agreement. Neither this C&O Agreement format nor the structure and format for a gas processing fee were ever adopted by the plant owners. [Transcript Vol. I, pp. 96-104 (pp. 103-104 Confidential); Confidential Exhibit 914, pp. 317, 328, 340, 357-359 ].

13.      The first proposed C&O Agreement was sent for owner approval in July, 1991. The major difference between the July, 1991, proposal and the prior drafts, Exhibits 913, 914, was removal of the concept of processing fees. All mention of processing fees was removed prior to distribution of the July, 1991, proposal. The agreement instead provided the ownership of the plant would pay all capital and operating costs. [Transcript Vol. I, pp. 106-107].

14.      The July, 1991, proposed C&O Agreement sent to the working interest owners was not approved. Although 78 percent of the owners accepted, the agreement required 90 percent acceptance with the remaining 10 percent nonconsent than assumed pro-rata by the 90 percent accepting. If more than 10 percent were nonconsent, then one or more of the accepting parties had to voluntarily assume, in this case, the 22 percent nonconsent. No party was willing to assume the 22 percent nonconsent, thus the July, 1991 proposed C&O Agreement was not approved. [Transcript Vol. I, pp. 107-108].

15.      Notwithstanding the failure of the July, 1991, proposed C&O Agreement, LL&E continued with plant design, and ultimately received a two-year air quality permit for a plant effective August, 1991. The permit required plant construction to begin no later then August, 1993. [Transcript Vol. I, p. 109].

16.      After the July, 1991, proposed C&O Agreement was not approved, LL&E held discussions with third parties to build and operate a plant. It also briefly considered constructing a pipeline to transport the gas as produced to Chevron’s Carter Creek plant for processing. LL&E and the working interest owners, in December, 1992, rejected all proposals for a market-based processing agreement, and ultimately concluded that in order to get the gas processed, the working interest owners, including LL&E, would have to build a plant. [Transcript Vol. I, pp. 109-124; Exhibit 104].

17.      A final C&O Agreement, to be effective January, 1993, was submitted to the working interest owners in March, 1993. The agreement included an authorization for expenditure of $79 million, the initial cost to build a plant. The agreement was approved by only 45 per cent of the working interest owners, however, the approving plant owners agreed to waive the 90 percent approval requirement and allow LL&E to assume the 55 percent nonconsent interests. The authorization for expenditure and the C&O Agreement were thus approved retroactive to January 1, 1993. [Transcript Vol. I, pp. 124-128 204-205, 207-209; Exhibit 915, p. 415].

18.      If the C&O Agreement did not included a provision for an owner to assume the nonconsent interests, even a small interest owner could have stopped construction of the plant. [Transcript Vol. I, p. 195].

19.      LL&E continued its efforts to get the 55 percent nonconsent interests to agree to the C&O Agreement as it was still LL&E’s intention to try to keep the reserves, the wells, the production, and the plant all in common ownership. Eventually, 98 percent of the working interest owners agreed to the final C&O Agreement. The remaining 2 percent nonconsent was owned by Samson Resources. LL&E agreed to carry Samson’s nonconsent interest, thus it paid Samson’s capital expense and operating expenses. LL&E eventually acquired Samson’s interest in 1998 through a property exchange in other areas. [Transcript Vol. I, pp. 129-134].

20.      LL&E, by agreeing to assume Samson’s 2 percent nonconsent interest, also agreed to pay the 2 per cent capital contribution attributable to Samson’s interest and assume Samson’s liability for 2 percent operating expenses. LL&E then took and processed an equivalent amount of raw gas which otherwise would have been Samson’s 2 percent share of production. Samson thus received no gas sale proceeds. This situation would continue as long as there was production from the well in which Samson owned an interest, or until Samson agreed to pay a processing fee for Lost Cabin to process its 2 percent gas. Samson was simply underproduced and LL&E was overproduced in a well. This over/under production was handled through gas balancing at the well which did not affect ownership in the plant. [Transcript Vol. I, pp. 193-194, 198, 205-206, 223-227].

21.      The intent of the final C&O Agreement was stated in the agreement by the working interest owners: “It is the intent of the owners hereto to have plant ownership correspond as closely as possible to each plant owner's committed working interest in the sour gas Paleozoic PAA”. [Transcript Vol. I, pp. 135, 136; Exhibit 915, p. JT415].

22.      The plant operator under the final C&O Agreement was LL&E. [Exhibit 915, p. JT423]. The duties of the operator were specified in Article IX of the Agreement. [Exhibit 915, pp. JT427-431]. The duties of the operator did not include collecting processing fees. [Transcript Vol. I, pp. 137-138; Exhibit 915].

23.      The capital costs for construction of the plant were to be shared proportionately by the working interest owners who approved the C&O Agreement based on their interest in the plant.

All Capital Expenditures made in connection with the Plant shall be paid by the Operator and charged to the account of the Owners. Each Owner shall be charged its proportionate part of such expenditures measured by its Plant Ownership Interest on the date such expenditures are made.

[Exhibit 915, p. JT435].

24.      These capital costs were included on the joint interest billings sent to each owner. The billings did not include depreciation or return on investment. The C&O Agreement also did not address depreciation or return on or of investment. [Confidential Transcript Vol. I, pp. 139-140].

25.      The C&O Agreement further provided each owner would be charged their proportionate share of operating expenses each month.

Each Owner shall be charged its proportionate share of Operating Expenses for each Accounting Period based on the Owner’s Plant Ownership Interest as of the first Day of any given Accounting Period.

[Exhibit 915, p. JT436].

26.      Operating expenses, as defined by the C&O Agreement, included a 12 per cent overhead charge as set forth in Exhibit B to the Agreement. These charges were to be paid to the operator to reimburse nondirect costs. Exhibit B explains the accounting procedures and allowances for the joint interest billings. Morrow stated the overhead charge was not intended as a return of or on capital for LL&E. [Transcript Vol. I, pp. 142-144; Exhibit 915, pp. JT402, JT436, JT467].

27.      Morrow testified the 12 percent overhead charge was intended to cover the expense of functions performed outside the confines of Lost Cabin but which are nevertheless part of doing business as a plant, such as accounting, tax, computer services, and management. Morrow stated it was not possible to specifically identify every cost or expense the 12 percent was intended to cover. The 12 percent was the result of negotiation amongst the plant owners. [Transcript Vol. I, pp. 175-180].

28.      Morrow stated that LL&E did not become operator of Lost Cabin to make money through the 12 per cent overhead charge. The overhead charge was intended to cover the nonquantifiable, indirect expenses which could not be specifically identified to the plant owners. The 12 per cent overhead charge was a negotiated percentage which might not cover all the indirect expenses incurred by LL&E in operating Lost Cabin. [Transcript Vol. I, pp. 196-198].

29.      Burlington pays its share of the 12 per cent overhead charge the same as all other plant owners. [Transcript Vol. III, pp. 568-570].

30.      Morrow testified that Exhibit H to the C&O Agreement, entitled Gas Processing Agreement, was intended to describe the day-to-day, month-to-month operation of the plant in contrast to the C&O Agreement itself which focused on capital expenditures, plant expansion and ownership. Exhibit H was intended to describe the “regular workaday duties” of plant operation. The Gas Processing Agreement, like the C&O Agreement, is structured as an agreement among the Lost Cabin owners, rather than an agreement between the plant owners and the individual producers. [Transcript Vol. I, pp. 145-147; Exhibit 915, p. 508].

31.      Exhibit H designated no separate producer party, only owners. Morrow stated it was not intended to generate revenue. The processing fees concept included in earlier drafts of the C&O Agreement was removed altogether. [Transcript Vol. I, pp. 147-149; Exhibit 915, p. 508].

32.      Exhibit H defined operating expenses, including a monthly overhead charge, in language similar to the main body of the C&O Agreement. [Transcript Vol. I, p. 148].

33.      Operating expenses, under Exhibit H, are billed monthly to the plant owners based on their working interest in the plant, not on throughput (the amount of gas processed by the plant). Operating expenses are incurred and fully billed to the working interest owners even though in a given month gas might not be processed through the plant. Exhibit H does not address capital costs of the plant. [Transcript Vol. I, pp. 149-150; Exhibit 915, p. 527].

34.      All gas reserves owned by a plant owner in the Madison Formation are dedicated to Lost Cabin. Morrow stated from practical perspective, no other plants could process the Madison Formation sour gas. [Transcript Vol. I, pp. 151-152; Exhibit 915, p. 516].

35.      Morrow testified that during his involvement with Lost Cabin the plant did not ever charge a processing fee to process gas. [Transcript Vol. I, p. 158].

36.      A third producing well, the Big Horn 4-36, was drilled into the Madison Formation in 1996, and completed in 1997. The well encountered the Madison Formation in a downdip position which extended over one thousand feet. From a reserve perspective, this greatly expanded the known reservoir, and as a result LL&E and the other plant owners decided to build a second processing train identical to the first plant. The capital costs of the second train were approximately $100 million. [Transcript Vol. I, pp. 160-162].

37.      The capital expense for the second train was billed to all working interest owners according to their plant percentages on a monthly basis. As testified by Morrow, the plant operator did not care where the plant owners got the money to pay the bill as long as the bill was paid. [Transcript Vol. I, pp. 218-219].

38.      LL&E, and then Burlington after its purchase of LL&E, operated the Madison Formation wells under a production agreement separate from the C&O Agreement for Lost Cabin. The production expenses for each well are indicated separately on the joint interest billings sent to the working interest owners in the wells. [Transcript Vol. I, pp. 166-168].

39.      Morrow testified the incentive for LL&E, and then Burlington, to act as operator of the plant was to control and move forward the development of the Madden Unit. [Transcript Vol. I, p. 181].

40.      Morrow also stated Burlington’s position that the charges on the joint interest billings were not a fee. They were operating expenses. It is Burlington’s position that fees are differentiated from costs by the fact that fees are based on a rate per MCF or throughput, while costs and expenses are billed monthly without regard to throughput. [Transcript Vol. I, pp. 188-189].

41.      Morrow testified if an entity other than a plant owner wanted gas processed at Lost Cabin, a separate processing agreement approved by all plant owners would be required. The same would be true if a plant owner wished to process gas at Lost Cabin which did not come from the defined participating area within the Madden Unit. [Transcript Vol. I, pp. 198-199; Exhibit 915, p. 419].

42.      Morrow testified, in his opinion, a processing fee is an amount paid to a plant owner who is then responsible for bearing all costs against that fee. The person who collects the fee for processing gas is responsible for dealing with whatever costs have to go against the fee. This is not the situation with Lost Cabin. There is no revenue in or out. The plant owners simply worry about paying their proportionate share of plants costs. [Transcript Vol. I, pp. 220-221].

43.      Tim Dover, a staff landman for ConocoPhillips, testified on behalf of Burlington. Dover still does work for Burlington with regard to Lost Cabin. He stated there have been no changes to the C&O Agreement since October, 1993. [Transcript Vol. II, pp. 233-235].

44.      Although there have been changes in plant ownership and well interests since 1993, the well owners and plant owners were the same in 2005. [Transcript Vol. II, pp. 236-238].

45.      If a new company acquires an interest in one of the wells whose production is dedicated to Lost Cabin, the assignee company automatically becomes an owner in Lost Cabin. If the assignment of interest includes specified language found in Exhibit G to the C&O Agreement, the assignee then has agreed to fulfill, perform, pay and discharge all duties, obligation, and liabilities of the assignor as set out in the C&O Agreement after the effective date of the assignment. [Transcript Vol. II, pp. 238-239; Exhibit 915, Exhibit G thereto p. JT506].

46.      If the BLM-defined participating area expands to include wells not previously dedicated to Lost Cabin, the working interest owners in the new wells become interest owners in Lost Cabin only if the then current Lost Cabin owners agree. If the plant owners do not agree, the new working interest owners do not become plant owners, and thus cannot process the gas attributable to their interests through Lost Cabin. The gas attributable to the new working owner’s interests is produced and processed by the current plant owners subject to a gas balancing agreement. Under such agreement, the new working interest owners are considered underproduced and the plant owners who took their gas and processed it are considered overproduced. The final result under the gas balancing agreement may be that the overproduced owners have to “cash balance”with the underproduced owners. [Transcript Vol. II, pp. 240 - 243; Exhibit 915, Section 5.8, p. JT415].

47.      If a new working interest owner is approved for plant ownership, the new owner is cost adjusted into the plant costs as well as into the costs for the Big Horn wells. The new owner is billed, on a single joint interest billing, for the capital and operating costs previously incurred, and payment is due upon receipt. Neither costs are time adjusted. The parties that initially paid the billed costs are reimbursed their proportionate share. The new working interest owner, as now a plant owner, is subject to the C&O Agreement. [Transcript Vol. II, pp. 244-245, 257; Exhibit 915, Section 5.8, p. JT415].

48.      In Dover’s experience, a plant owner who processes gas for a non-plant owner sets the processing fee to recoup his capital costs, processing costs, and earn an incremental amount of profit. [Transcript Vol. II, pp. 247-249].

49.      Dover further stated, in his experience, the accounting procedures set forth in Exhibit B to the C&O Agreement are not designed or intended to recoup capital costs or capture a profit. The express purpose of Exhibit B is to compensate the operator for expenses associated with operation of the plant. The 12 percent overhead charge is intended to compensate the operator for indirect costs of salaries and expenses for employees not physically located at the plant but who nevertheless provide services for the benefit of the owners of the facility. [Transcript Vol. II, pp. 249-250; Exhibit 915, Exhibit B, p. JT467].

50.      Dover asserts the C&O Agreement provides only recovery of capital costs and operating expenses. The billing and payment of these costs, in his estimation, does not constitute a fee. [Transcript Vol. II, p. 253].

51.      Even though two owners in the plant, Inexco and LL&E, are related by virtue of corporate structure, they are treated individually the same as any other owner. [Transcript Vol. II, p. 261].

52.      Brent Lohnes is the plant manager for Lost Cabin now owned by ConocoPhillips after its purchase of Burlington. He has worked at Lost Cabin since January, 2002, and has been plant manager since June, 2005. As plant manager, he is responsible for operations of the plant in conformance with state and federal regulations as well as internal policies and practices. He is responsible for the accurate reporting of production volumes, and all financial matters including capital expenses, operating, and maintenance budgets, and monthly expenses. [Transcript Vol. II, pp. 263-265].

53.      Lohnes stated the total cost of Lost Cabin, including all three trains, is approximately $500 million. The third train was added and commissioned in 2002. It is roughly three times the size of the first two trains, with a nominal capacity of 180 million cubic feet/day. All three trains were custom-designed to handle the unique characteristics of the Madison Formation gas. For example, Lost Cabin required stainless steel or nickel-alloy-based piping to mitigate the corrosive nature of that gas. [Transcript Vol. II, pp. 268-275].

54.      There are seven wells which flow from the Madison Formation into Lost Cabin. The gas composition, gas temperature, and flow rates of all seven wells are the same as the first two wells drilled. The Madison Formation gas is one of the most toxic gas streams being produced anywhere. The gas is 12 percent H2S, and 20 percent CO2. Interstate pipeline specifications allow no more than 3 percent CO2, and 4 PPM of H2S. There are 10,000 PPM per one percent, thus the gas stream as produced contains 120,000 PPM of H2S. Lost Cabin must reduce the H2S content to 4 PPM. [Transcript Vol. II, pp. 269-272; Exhibit 108].

55.      The gas from the Madison Formation can not be processed at a conventional gas plant because of its high temperature at the plant inlet, the free elemental sulfur, and the corrosive nature caused by the H2S and CO2 concentrations. The Madison Formation gas can not be processed at either the Carter Creek or the LaBarge processing plants. The Carter Creek plant processes CO2 through the sulfur recovery unit. The Carter Creek gas stream has 5 percent CO2 while the Madison Formation gas has 20 percent CO2. If Madison Formation gas were processed at Carter Creek, the high CO2 content would “snuff out” the flame in the sulfur recovery unit. In addition, the gas could not be transported to LaBarge since as the temperature drops in the pipelines, the elemental sulfur would plate out and clog the lines. Conversely, gas flowing to the LaBarge Plant could not be processed at Lost Cabin because it could not handle the high carbon dioxide levels of the LaBarge gas. [Transcript Vol. II, pp. 283-287].

56.      Lohnes testified the Lost Cabin operating expenses remain the same even if the plant is operating at minimum capacity. If the plant is down because of a component failure, the operating and maintenance costs actually increase as the result of additional labor and material costs incurred. The operating expenses, when the plant is down, are billed to the plant working interest owners each month the same as in any other month. [Transcript Vol. II, pp. 273, 294].

57.      Michael A. Zeeb is a CPA and certified fraud examiner with an extensive background in the oil and gas industry including review of processing agreements. He offered his expert opinions on behalf of Burlington through a confidential written report and testimony on use by the Department of the comparable value method for valuing 2005 production from Lost Cabin. [Transcript Vol. II, pp. 296-301; Confidential Exhibit 100].

58.      Zeeb’s written report focused on five areas:

(A)     the processing costs the Department deducted to arrive at Burlington’s taxable value;

(B)     the types of processing costs incurred by Burlington after the inlet of the plant, and Exhibit H of the C&O Agreement;

(C)     the processing costs which can be inferred by the Department if it implements the comparable value method using the Gas Processing Agreement to impute a processing fee to Burlington;

(D)     the categories of processing costs which comprise a market-based fee; and

(E)     compare a market based fee to the Gas Processing Agreement and whether that agreement represents a comparable value as defined by the Wyoming Supreme Court and State Board of Equalization.

[Transcript Vol. II, pp. 301-303, 311-336; Confidential Transcript Vol. II, pp. 305-310; Confidential Exhibit 100, p. BR 0006].

59.      Zeeb stated his opinion the Department deducted from gross revenues for 2005 some direct operating costs, labeled Direct Processing Costs on Confidential Exhibit 909, p. JT 67, and plant depreciation as those figures appeared on the annual reports filed by Burlington using the proportionate profits methodology. [Confidential Transcript Vol. II, p. 309].

60.      Zeeb asserts, in his experience, the processing costs incurred by Burlington after the inlet to the plant include the costs associated with building the plant, the costs of day-to-day operations, and the cost of money. These costs, which are typical for processing plants, are included in the value of processing. [Transcript Vol. II, pp. 311-313].

61.      Zeeb testified that in his experience most processing fee agreements are based in some fashion on gas flowing through a plant, i.e. on throughput. These agreements are negotiated arms-length, are thus market driven, and encompass a sufficient fee to cover the cost to build, the cost to operate, the cost of money, and a profit element. If entities are acting separately in their respective capacities as processor and producer, Zeeb would expect the processing fee to include the same components. [Transcript Vol. II, pp. 314-317].

62.      Zeeb asserts there are three major cost categories in a processing fee negotiated by parties with different economic interests - operating costs, return of capital, and return on capital. Operating costs are the recurring costs of running the processing plant. Return of capital is captured by depreciation. Return on capital involves the cost of money, being either interest charged to borrow money, or the amount of interest foregone if you use savings; and a profit element. Zeeb asserts a market based processing fee would be designed to capture all of theses costs. The processor gets all costs plus a return on investment. Unless the processing fee covers all these costs, it does not properly account for the complete value of processing. [Transcript Vol. II, pp. 319-324].

63.      Zeeb asserts Exhibit H to the C&O Agreement, even though entitled Gas Processing Agreement, is simply an accounting mechanism for a sharing agreement which addresses operating costs. Such costs, however, are only one element of a true processing fee. The Gas Processing Agreement does not address return of capital, the cost of money component, nor profit. Zeeb, based on his professional experience, argued a processing fee cannot be inferred or estimated from Exhibit H for lack of reliable information. [Transcript Vol. II, pp. 326-328].

64.      Zeeb acknowledged the C&O Agreement, including all exhibits, addressed operating expenses, which is one of the cost elements of a processing fee. The C&O Agreement does not, however, address return of capital. It simply sets out how the capital cost of the plant is to be shared. The C&O Agreement also does not address the cost of money or a profit element. [Transcript Vol. II, pp. 328-329].

65.      Zeeb asserted Burlington’s full cost of processing can not be derived, inferred or estimated from the language of the C&O Agreement even taken as a whole. The Agreement does not address all costs required to measure the value added to Madison Formation gas by processing. It does not, in particular, address the profit element. [Transcript Vol. II, pp. 329-330].

66.      The C&O Agreement, according to Zeeb, does not reflect what an entity separate from a producer would charge for processing Madison Formation gas. The Agreement simply sets forth a mechanism for paying capital and operating expenses through joint interest billings which do not included depreciation since capital has already been billed. [Transcript Vol. II, pp. 330-331, 357, 361-364].

67.      Zeeb argued it is incorrect and in violation of accounting rules to simply add together the charges on the joint interest billings to derive a gas processing fee. The charges on the joint interest billings in a given year could actually exceed the value of the processed gas, thus using such a method could end up with a negative taxable value. [Transcript Vol. II, pp. 331-333].

68.      Zeeb alleged the Department, in issuing its Notice of Valuation, failed to properly account for indirect operating costs, thus the processing deduction is too low, and the resulting taxable value of the Lost Cabin gas is therefore too high. [Transcript Vol. II, pp. 334-335].

69.      The 12 percent fee set out in Exhibit H to the C&O Agreement, according to Zeeb, is not a return of investment or profit component. [Transcript Vol. II, p. 360 ].

70.      Zeeb asserted a rational plant owner would not set a fee for processing gas for a non-plant owner based solely on the costs set forth in the C&O Agreement. The fee should include all operating costs as well as return of capital, return on capital, and arguably a profit. [Transcript Vol. II, pp. 365-366].

71.      Anthony F. Fasone, a senior adviser in the royalty compliance group at ConocoPhillips, testified on behalf of Burlington. [Transcript Vol. II, pp. 369-370].

72.      ConocoPhillips purchased Burlington in March, 2006. Burlington, as operator of both Lost Cabin and the well field in 2005, reported and paid taxes on behalf of all working interest owners on 2005 production. [Transcript Vol. II, p. 370].

73.      The operator of Lost Cabin, since it went online in 1995 through 2004 production, with Department approval after multiple reviews of the C&O Agreement, was allowed to report and pay taxes for all working interest owners on value derived using the proportionate profits methodology. [Transcript Vol. II, pp. 373-399; Exhibits 901, 902, 903, 904, 905, 920, 921, 922, 923, 924, 925, 926, 927, 929, 930, 932].

74.      The C&O Agreement adopted in 1993, which was still in effect without change for 2005 production, was first sent to the Department in December, 1999. The Department acknowledged that it had received and reviewed the agreement when it allowed use of the proportionate profits method for production years 2000, 2001, and 2002. [Transcript Vol. II, pp. 382-384; Exhibits 931, 932].

75.      The Department, by letter dated April 1, 2003, allowed use of the proportionate profits method to value the gas processed at Lost Cabin for production years 2003, 2004, and 2005. The Department letter again mentioned review of the C&O Agreement previously supplied in 1999. The letter further reiterated the Department’s position with regard to its ability to change valuation methods and use the comparable value method for 2003, 2004, or 2005 production.

Should circumstances change and BR becomes aware of Comparable Values that could be utilized to value your production for any given year, please notify the Department. Through its further investigation if the Department discovers Comparable Values that could be utilized to value your production, the Department will notify BR. Please understand that this substitution of valuation methodology is subject to review by the Wyoming Department of Audit.

[Exhibits 902, 903, p. JT52; Transcript Vol. II, pp. 386-387, 400].

76.      Fasone pointed out the costs, which are required to be reimbursed under the C&O Agreement, are not based on the volume of gas processed through the plant. The plant owners pay those costs whether or not gas flows through Lost Cabin. [Transcript Vol. II, pp. 392-393].

77.      The Department, in response to the Wyoming Supreme Court decision concerning the Whitney Canyon gas plant, (BP America Production Co. et al. v. Department of Revenue, 2005 WY 60, 112 P.3d 596 (Wyo. 2005), sent a letter dated August 10, 2005, to Burlington asking again for all processing agreements associated with Lost Cabin, and reasons why those agreements could not be used as a source of comparable value. Before Burlington responded to the August 10^th letter, the Department issued its selection letter dated August 26, 2005, for production years 2006, 2007, and 2008, identifying comparable value as the method to be used for producer processed gas if the netback method was inapplicable. [Transcript Vol. II, p. 401; Exhibits 906, 907].

78.      Fasone, on behalf of Burlington, in responding to the Department selection letter and letter of August 10^th, reiterated Burlington’s position that the C&O Agreement did not charge a processing fee, but rather defined the obligations of the plant owners in sharing the operating costs and capital expenses for Lost Cabin. Burlington did not receive a response to its letter, and thus filed its annual report for 2005 production using the proportionate profits method. [Transcript Vol. II, pp. 402-403; Exhibits 908, 909].

79.      The Department issued a Notice of Valuation on April 17, 2006, which calculated taxable value for 2005 Lost Cabin production using the proportionate profits methodology including taxes and royalties in the direct cost ratio as reported by Burlington. The Department, based on this Notice, had thus valued the Lost Cabin production for 2003, 2004, and 2005 using proportionate profits as agreed by the Department in 2003. [Transcript Vol. II, p. 404; Exhibits 903, 910].

80.      The Department issued a second Notice of Valuation dated May 5, 2006, for 2005 Lost Cabin production. This Notice, as noted in a May 16, 2006, letter from Craig Grenvik, Administrator of the Department’s Mineral Tax Division, valued the 2005 production using the comparable value method. Fasone testified that Burlington had, prior to the second Notice and Grenvik’s letter, no indication from the Department that it would be valuing the 2005 production using the comparable value method. The Department identified no changed factual circumstances as a basis for the methodology change. Fasone testified the Department had never requested copies of the joint interest billings sent to plant owners, and that neither the C&O Agreement nor Exhibit H thereto had changed from what had been supplied to the Department in 1999. [Transcript Vol. II, pp. 404-406; Exhibits 910, 911, 912].

81.      Fasone asserted the first indication Burlington received that the Department would value 2005 production using the comparable value methodology was the May valuation notice and Grenvik’s May letter. Burlington had received no prior notice as would be anticipated by the Department’s April 1, 2003, letter allowing proportionate profits which also indicated the Department would notify Burlington if it intended to change to the comparable value method. [Transcript Vol. II, pp. 430-431; Exhibit 903].

82.      The letter from the Department to Burlington dated August 10, 2005, did indicate the Department was considering the comparable value method, but noted only the required selection for 2006 through 2008 production. The letter made no mention of 2005 production. [Transcript Vol. II, p. 417; Exhibit 906].

83.      Fasone presented confidential testimony on behalf of Burlington describing two confidential exhibits he had developed. Fasone, on Exhibit 101, summarized the costs allowed by the Department under the comparable value method, and also identified those costs on the joint interest billings which were not allowed by the Department. On Exhibit 102, Fasone calculated a return on investment for Lost Cabin using varying rates of return. [Confidential Transcript Vol. II, pp. 408-420; Confidential Exhibits 101, 102].

84.      The Department, using the comparable value method in its May valuation, allowed Burlington a credit for direct costs. The Department also allowed a credit for depreciation. Both amounts were indicated on Burlington’s proportionate profits annual report for 2005 production. The direct costs, but not depreciation, appear on the joint interest billings. [Confidential Transcript Vol. II, pp. 408-409; Confidential Exhibit 101].

85.      The Department did not allow as a credit in its May valuation certain costs which appeared on the joint interest billings, including indirect costs and the general manager’s salary, benefits, and expenses. [Confidential Transcript Vol. II, pp. 409-410; Confidential Exhibit 101].

86.      Fasone calculated, for illustration purposes, a cost of capital using returns on investment based on the undepreciated capital for Lost Cabin as of January 1, 2005. [Exhibit 102]. Fasone did this depreciation calculation using a straight line 20-year life to reach the undepreciated balance as of January 1, 2005, for purposes of the proportionate profits valuation calculation since each individual plant owner did not, and need not, report to Burlington their actual depreciation. Burlington, as operator of the plant and well field, reports and pays tax for all plant owners, thus to report using the proportionate profits methodology Burlington must calculate depreciation for the entire plant. [Confidential Transcript Vol. II, pp. 410-413, Transcript Vol. II, pp. 422, 431-432; Confidential Exhibit 102].

87.      The capital expenses for Lost Cabin, according to Fasone, are billed monthly to the plant owners. Burlington gets no information on how the funds are generated by each owner to pay their respective capital costs. [Confidential Transcript Vol. II, pp. 414-415].

88.      The joint interest billings include all capital and operating expenses for Lost Cabin. Each plant owner is required to pay their fractional portion of the total billed. Capital expenses were billed monthly on the joint interest billings as, for example, Train #3 was being built. As a result, when Train #3 came online in September, 2002, most, if not all capital expenses associated with its construction had been billed and paid by each owner. [Confidential Transcript Vol. II, pp. 415-419; Transcript Vol. II, pp. 434-435; Confidential Exhibit 913].

89.      Fasone asserted that if the Department were to use the C&O Agreement as a comparable and simply deduct the amounts billed on the joint interest billings, it is possible the billings in any given year would exceed revenue net of exempt royalty resulting in a zero or negative taxable value for the processed gas. Fasone stated, for example, if the Department used as a comparable value the amounts billed for production years 2000, 2001, and 2002, when Train #3 was being built, the capital costs billed for the three years would have exceeded, in the aggregate, the total revenue net of exempt royalty for the same three years. [Transcript Vol. II, pp. 419-420].

90.      Craig Grenvik, administrator of the Mineral Tax Division, testified on behalf of the Department. [Transcript Vol. II, pp. 443-444].

91.      The Department has consistently selected the comparable value method for valuing the production of producer-processors in Wyoming based on its conclusion such method provides a closer estimation of fair market value than the other available methods. [Transcript Vol. II, pp. 447-448].

92.      When the Department, in 1999, requested Burlington supply all agreements and contracts for gas being processed at Lost Cabin, Burlington supplied only the C&O Agreement with attached exhibits. There were no other contracts similar to what the Department had received with regard to the Whitney Canyon, Painter, and Carter Creek plants. Grenvik stated the Department concluded, at that time, it could not value the Lost Cabin gas using comparable value as it did not see any non-dedicated gas being processed at the plant, and none of the gas from the Madden Unit was being processed at any other plant. The Department did not try to make a direct comparison between Lost Cabin and other sour gas plants because the Madden Unit gas can not get to any other plant. [Transcript Vol. II, pp. 453-454, 458-459; Exhibit 930].

93.      The Department also concluded for production years 2003, 2004, and 2005, based on its review of the C&O Agreement, the comparable value method could not be used for Lost Cabin production. The Department still held this conclusion even after the initial Board decision regarding the Whitney Canyon processing plant, Union Pacific Resources, et al., Docket No. 2000-147, June 9, 2003, 2003 WL 21774603 (Wyo. St. Bd. Eq.). [Transcript Vol. II, pp. 465-467, Vol. III, pp. 477-481; Exhibits 901, 902, 903, 904, 905]

94.      The Department, as stated in a discovery response in appeals filed by BP America, Chevron, and Anadarko in 2003 challenging the valuation of 2002 production at Whitney Canyon, had no evidence of gas from other than the dedicated wells being processed at Lost Cabin. The Department thus conclude it could not use the comparable value methodology to value Lost Cabin production. [Transcript Vol. II, pp. 460-462; Exhibit 918].

95.      The Department perceived a change in the law which would allow use of the comparable value method for Lost Cabin based on the Wyoming Supreme Court decision in May, 2005, with regard to Whitney Canyon, BP America Production Co. et al. v. Department of Revenue, 2005 WY 60, 112 P.3d 596 (Wyo. 2005). The Department now asserts the C&O Agreement for Lost Cabin, based on the Supreme Court decision, fulfills the requirements for use of the comparable value methodology. [Transcript Vol. II, pp. 464-465; Transcript Vol. III, pp. 481, 485-498; Exhibits 910, 911].

96.       The Department asserts the requirements of Wyo. Stat. Ann. §39-14-203(b)(vi)(B), the comparable value methodology, to wit: arm’s length sales price, like quantity, like quality, and terms and conditions, are fulfilled by the Lost Cabin C&O Agreement. It asserts the Agreement contains a processing fee consisting of capital expenditures, operating costs, and indirect charges for overhead, including the 12 per cent fee, as set forth in the C&O Agreement itself, and Exhibit B thereto. [Transcript Vol. III, pp. 489-497].

97.      Grenvik does not believe a processing fee needs to be tied to throughput. [Transcript Vol. III, p. 493].

98.      The Department asserts each of the owners of Lost Cabin fulfill the requirements of Wyo. Stat. Ann. §39-14-203(b)(vi)(B) as being “other parties.” It argues the other parties are all of the other signatories to the C&O Agreement, so each individual owner is another party to all the other owners. If there are multiple parties to a construction and operating agreement, the multiple parties are other parties. This position is the focus of the Department’s argument that the C&O Agreement sets forth an applicable processing fee. [Transcript Vol. III, pp. 498-499, 505-506].

99.      Burlington has always provided all information the Department has ever requested, and there are no documents pertaining to Lost Cabin other than the C&O Agreement. There are no contracts or agreements signed between the plant in its capacity as the plant, and the individual producers unlike the Whitney Canyon plant. In the instance of Whitney Canyon, the plant owners, acting together, signed separate contracts with the individual producers. [Transcript Vol. III, pp. 502-504].

100.    The Department asserts that Burlington sending a bill to the other plant owners for their share of plant expenses is the functional equivalent of charging them a fee. And because each owner has agreed to pay their share of expenses they are charging each other a fee. The Department contends this is true even if no gas is processed by the plant when the charges are billed. Grenvik asserts the charges for plant expenses are a charge for processing gas. [Transcript Vol. III, pp. 506-511].

101.    It is the Department’s position that to constitute a processing fee, there must be a charge or other price for the act of processing gas. It acknowledges that the joint interest billings under the Lost Cabin C&O Agreement are levied and must be paid whether or not gas is processed. [Transcript Vol. III, pp. 513-514].

102.    The objective, the purpose of the comparable value methodology, according to the Department, is to determine an appropriate charge, an appropriate fee, that when deducted from gross revenues will yield fair market value for processed gas. The processing fee should reflect the appropriate charge for the value added by gas processing which occurs after the inlet of the gas plant, the point of valuation. The Department contends the taxable value for any Lost Cabin plant owner can be derived by subtracting from the owner’s gas sales the joint interest billings the owner received during the production year. The fair market value of the gas at the plant inlet can thus be derived by simply subtracting whatever joint interest billings are issued for a particular production year from gross revenues. [Transcript Vol. III, pp. 514-518, 523].

103.    A return on investment is not a component of the cost of processing under the Department interpretation of the Lost Cabin processing fee found in the C&O Agreement. Grenvik asserts it is irrelevant. [Transcript Vol. III, pp. 520, 528].

104.    The Department’s view is that the C&O Agreement for Lost Cabin constitutes a procedure by which the full and fair costs of processing are billed to the various plant owners. [Transcript Vol. III, p. 525].

105.    The Whitney Canyon C&O Agreement contains a separate processing fee set out as a percentage (25%) of the remnant product, and also charges the plant owners their share of operating costs. The Department chose not to include the operating costs as part of the processing fee at Whitney Canyon. Grenvik stated with regard to Lost Cabin, the C&O Agreement contains no provision charging a fee. The Agreement simply addresses operating costs and expenditures which the Department considers to be a processing fee at Lost Cabin, but not part of the fee at Whitney Canyon. [Transcript Vol. III, pp. 530-533].

106.    Grenvik agreed the objective of the comparable value statute, as stated by this Board and affirmed by the Wyoming Supreme Court, is to determine the existence of a processing fee which the taxpayer, in this case Burlington, might be expected to pay a third party to provide processing services. [Transcript Vol. III, p. 533].

107.    Grenvik also agreed the point of the comparable value statute is to get to a number that would be a reasonable approximation of what a third party would pay to have their gas processed, and that the third party, under any circumstances, would not pay only plant operating expenses as billed on joint interest billings. [Transcript Vol. III, p. 552].

108.    One of the reasons the Department assessed Burlington using comparable value was that the Department wanted to “fend off” assertions made in other cases that it was treating other producers unfairly as compared to Burlington. The Department had to take the position it did in order to get a definite answer. [Transcript Vol. III, p. 534].

109.    This valuation of Lost Cabin production is the first instance in which the Department has changed valuation methodology from what was previously approved during a three-year valuation cycle. [Transcript Vol. III, pp. 538-539].

110.    Grenvik agreed in the Whitney Canyon situation, a plant owner could, in theory, recover through the share of the processing fee it receives, more than it actually paid to process its own gas through the Whitney Canyon plant. The same situation is not possible at Lost Cabin. [Transcript Vol. III, p. 514].

111.    Grenvik stated, with regard to the Whitney Canyon plant, there are four agreements, and in each instance the agreement is between a producer and the plant owners. The Lost Cabin agreement, however, refers to the signatories only as plant owners. It is a common agreement with everybody. [Transcript Vol. III, pp. 566-567].

112.    Any portion of the Conclusions of Law: Principles of Law or the Conclusions of Law: Application of Principles of law set forth below which includes a finding of fact may also be considered a Finding of Fact and, therefore, is incorporated herein by reference. In addition, the extensive history of the comparable value litigation has prompted us to address, as Findings of Fact, some matters which might also be characterized as Conclusions of Law, and accordingly any such Conclusions of Law are incorporated by reference into our discussion of Conclusions of Law.

CONCLUSIONS OF LAW - PRINCIPLES OF LAW

113.    The role of this Board is strictly adjudicatory:

It is only by either approving the determination of the Department, or by disapproving the determination and remanding the matter to the Department, that the issues brought before the Board for review can be resolved successfully without invading the statutory prerogatives of the Department.

Amoco Production Company v. Wyoming State Bd. of Equalization, 12 P.3d 668, 674 (Wyo. 2000). The Board’s duty is to adjudicate the dispute between taxpayers and the Department.