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 10th 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 10th, 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.

114.    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. Ann. § 39-11-102.1(c)(iv).


115.    “The burden of proof is on the party asserting an improper valuation.” Amoco Production Company v. Wyoming State Bd. of Equalization, 899 P.2d 855, 858 (Wyo. 1995); Teton Valley Ranch v. State Bd. of Equalization, 735 P.2d 107, 113 (Wyo. 1987); Britt v. Fremont County Assessor, 2006 WY 10, ¶ 17, 126 P.3d 117, 123 (Wyo. 2006); Thunder Basin Coal Company v. Campbell County, Wyoming Assessor, 2006 WY 44, ¶ 13, 132 P.3d 801, 806 (Wyo. 2006); Chevron U.S.A., Inc. v. Department of Revenue, 2007 WY 79, ¶ 30, _____ P.3d _____ (2007 WL 1377890)(2007). The Board’s Rules provide that:

 

[T]he 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. If Petitioner provides sufficient evidence to suggest the Department determination is incorrect, the burden shifts to the Department to defend its action….


Rules, Wyoming State Board of Equalization, Chapter 2 § 20.


116.    The Wyoming Legislature “…has directed the Department to value natural gas production that is not sold at or prior to the point of valuation by bona-fide arms-length sale pursuant to one of four methods….” BP America Production Company v. Department of Revenue, 2005 WY 60, ¶ 5, 112 P.3d at 600. See also, Chevron U.S.A., Inc. v. Department of Revenue, State of Wyoming, 2007 WY 79, ¶¶ 11, 12, 13, _____ P.3d _____ (2007 WL 1377890)(2007). The four methods are comparable sales, comparable value, netback, and proportionate profits. Id. The method at issue in this case, comparable value, is defined as follows:

 

(B) Comparable value – The fair market value is the arms-length sales price less processing and transportation fees charged to other parties for minerals of like quantity, taking into consideration the quality, terms and conditions under which the minerals are being processed or transported;


Wyo. Stat. Ann. § 39-14-203(b)(vi)(B).


117.    “...[T]he objective of the comparable value statute is for the Department to find reliable information about processing fees paid by other taxpayers in similar situations, from which the Department can make reasonable inferences as to a particular taxpayer’s processing costs. …The statute requires the Department find processing fee arrangements from similarly situated producers.” BP America Production Company v. Department of Revenue, 2005 WY 60, ¶¶ 19, 20, 112 P.3d at 606. See also, Chevron U.S.A., Inc. v. Department of Revenue, 2007 WY 79, ¶¶ 18, 19, _____ P.3d _____ (2007 WL 1377890)(2007).


118.    The Wyoming Supreme Court has summarized the procedure the Board must follow when an oil and gas taxpayer challenges the fair market value determined by the Department:

 

The Department’s valuations for state-assessed property are presumed valid, accurate, and correct. Chicago, Burlington & Quincy R.R. Co. v. Bruch, 400 P.2d 494, 498-99 (Wyo. 1965). This presumption can only be overcome by credible evidence to the contrary. Id. In the absence of evidence to the contrary, we presume that the officials charged with establishing value exercised honest judgment in accordance with the applicable rules, regulations, and other directives that have passed public scrutiny, either through legislative enactment or agency rule-making, or both. Id.

 

The petitioner has the initial burden to present sufficient credible evidence to overcome the presumption, and a mere difference of opinion as to value is not sufficient. Teton Valley Ranch v. State Board of Equalization, 735 P.2d 107, 113 (Wyo. 1987); Chicago, Burlington & Quincy R.R. Co., 400 P.2d 499. If the petitioner successfully overcomes the presumption, then the Board is required to equally weigh the evidence of all parties and measure it against the appropriate burden of proof. Basin [Electric Power Coop. Inc. v. Dep’t of Revenue, 970 P.2d 841,] at 851 [(Wyo. 1998)]. Once the presumption is successfully overcome, the burden of going forward shifts to the Department to defend its valuation. Id. The petitioner however, by challenging the valuation, bears the ultimate burden of persuasion to prove by a preponderance of the evidence that the valuation was not derived in accordance with the required constitutional and statutory requirements for valuing state-assessed property. Id.


Amoco Production Company v. Department of Revenue et al., 2004 WY 89, ¶¶ 7-8, 94 P.3d 430, 435-436 (Wyo. 2004); accord, Airtouch Communications, Inc. v. Department of Revenue, State of Wyoming, 2003 WY 114, ¶ 12, 76 P.3d 342, 348 (Wyo. 2003); Colorado Interstate Gas Company v. Wyoming Department of Revenue, 2001 WY 34, ¶¶ 9-11, 20 P.3d 528, 531 (Wyo. 2001). The presumption the Department correctly performed the assessment rests in part on the complex nature of taxation. Airtouch Communications, Inc., supra, 2003 WY 114 ¶ 13, 76 P.3d at 348.


119.    The uniformity of assessment requirement mandates only that the method of appraisal be consistently applied, recognizing there will be differences in valuation resulting from application of the same appraisal method:

 

The Board contends that reliance upon hypothetical costs is required because of the mandates for uniform assessment (Art. 15, § 11) and equal uniform taxation (Art. 1, § 28) found in the Constitution of the State of Wyoming. These provisions do not require, however, that all minerals of the like kind be assigned the same value. Uniformity of assessment requires only that the method of appraisal be consistently applied. Hillard v. Big Horn Coal Company, supra. It is an intrinsic fact in mineral valuation that differences in values result from the application of an appraisal method.


Appeal of Monolith Portland Midwest Co., Inc., 574 P.2d 757, 761 (Wyo. 1978).


120.    A taxpayer “aggrieved by any final administrative decision of the Department may appeal to the state board of equalization.” Wyo. Stat. Ann. § 39-14-209(b)(i). Oil and gas taxpayers are entitled to this remedy:

 

Following [the Department’s] determination of the fair market value of... natural gas production the department shall notify the taxpayer by mail of the assessed value. The person assessed may file written objections to the assessment with the state board of equalization within thirty (30) days of the date of postmark and appear before the board at a time specified by the board...


Wyo. Stat. Ann. § 39-14-209(b)(iv).

  

121.    This appeal is brought under statutes which do not establish any specific standard to guide the Board’s review. Wyo. Stat. Ann. § 39-14-209(b). In the absence of specific standards set by statute or rule, we judge the Department’s valuation by the general standard that the valuation must be in accordance with constitutional and statutory requirements for valuing state-assessed property. Amoco Production Company v. Department of Revenue et al., 2004 WY 89, ¶¶ 7-8, 94 P.3d 430; Wyo. Stat. Ann. § 39-14-209(b)(vi). In doing so, we must take into account “the rules, regulations, orders and instructions prescribed by the department.” Wyo. Stat. Ann. § 39-11-102.1(c)(iv). We also consider the case in the context of the Board Rule governing the burdens of going forward and of persuasion. Rules, Wyoming State Board of Equalization, Chapter 2, § 20. Chevron U.S.A., Inc., et al., Docket No. 2002-54 (January 25, 2005), 2005 WL 221595 (Wyo. St. Bd. Eq.).



CONCLUSIONS OF LAW: APPLICATION OF PRINCIPLES OF LAW


122.    Burlington brought this appeal pursuant to Wyo. Stat. Ann. §§ 39-14-209(b) and 39-13-102(n). [Notice of Appeal]. We judge the Department’s valuation by the general standard that the valuation must be in accordance with constitutional and statutory requirements for valuing state-assessed property. Amoco Production Company v. Department of Revenue et al, 2004 WY 89, ¶¶ 7-8, 94 P.3d 430, 435-436; Wyo. Stat. Ann. § 39-14-209(b)(vi). The burden of going forward and the burden of ultimate persuasion rests with Burlington. Rules, Wyoming State Board of Equalization, Chapter 2, § 20.


123.    The Department’s decision to apply comparable value methodology to value the 2005 Lost Cabin gas production implicitly rests on the Department reaching two conclusions. The first is that there are “other taxpayers” in similar situations who are paying a processing fee to have their gas processed. The second is that reasonable inferences as to Burlington’s processing costs can be drawn from those fees paid by other taxpayers.


124.    Burlington, in order to prevail in its challenge of use by the Department of the comparable value method, must overcome the presumption the Department’s conclusions are valid, accurate, and correct. If Burlington presents sufficient evidence to bring into question the Department’s conclusions, the burden then shifts to the Department to defend its conclusions. Conclusions, ¶ 115.


125.    The Department, since the method became available, has consistently selected the comparable value method to value producer-processed gas. Findings, ¶ 91; [Exhibits 901, 907, 919, 921, 925].


126.    The Department has, however, agreed to value gas processed at Lost Cabin since the plant went online in 1995, through 2004 production, using the proportionate profits method rather than the comparable value method. Findings, ¶ 73.


127.    The C&O Agreement for Lost Cabin in effect for 2005 production is the same agreement in effect when the plant went online in 1995. A copy of the Agreement was first supplied to the Department in December, 1999. The Department acknowledged receipt and review of the Agreement when it authorized the use of the proportionate profits method rather then the comparable value method to value gas production at Lost Cabin for production years 2003 through 2005. Findings, ¶¶ 74, 75, 92, 93.


128.    The Wyoming Supreme Court, in May, 2005, issued an opinion which analyzes use of the comparable value method to value producer-processed gas at the Whitney Canyon Gas Plant. BP America Production Co. et al. v. Department of Revenue, 2005 WY 60, 112 P.3d 596 (Wyo. 2005) (BP America).


129.    The Department, in response to the BP America decision, again contacted Burlington by letter dated August 10, 2005, and requested all processing agreements associated with Lost Cabin, along with an explanation why the agreements could not be used as comparables. The Department, a few days later, issued its selection-of-method letter dated August 26, 2005, pursuant to Wyo. Stat. Ann. § 39-14-203(b)(vi), identifying comparable value as the method for valuing producer-processed gas for production years 2006, 2007, and 2008. Findings, ¶ 77.


130.    Burlington responded to both letters by reiterating its position the C&O Agreement, the only agreement between the plant owners, did not provide for a processing fee. Burlington did not receive a response from the Department. Burlington thus filed its annual report for 2005 production using the proportionate profits method. Findings, ¶ 78.


131.    The Department issued its original Notice of Valuation for the 2005 Lost Cabin production on April 17, 2006. This Notice utilized the proportionate profits method based on the annual report filed by Burlington. The Department then issued a second Notice of Valuation dated May 5, 2006. This second Notice derived a taxable value using the comparable value methodology as noted in a May 16, 2006, letter from Grenvik to Burlington. Findings, ¶¶ 79, 80.


132.    The Department, based on its interpretation of the BP America decision, concluded the “law had changed” from its previous interpretation of the comparable value statute, and based on this change, the Lost Cabin C&O Agreement did in fact fulfill the requirements for use of the comparable value method to value the 2005 production. Findings, ¶¶ 95, 96.


133.    The Department, after the BP America decision, concluded each of the owners of Lost Cabin fulfilled the requirements of the comparable value statute as “other parties” to each other since there were multiple parties to the C&O Agreement similar to the situation with the Whitney Canyon gas plant. Findings, ¶ 98.


134.    The Department further concluded the Lost Cabin C&O Agreement, including all exhibits, but especially its Exhibits B and H, set forth a processing fee. The Department asserts that because each owner had agreed to pay its proportionate share of all plant expenses, each owner was thus charging every other owner a fee equal to each owner’s respective share of expenses. The Department argues the C&O Agreement set forth a procedure to bill each owner the full costs of processing their respective gas production. Findings, ¶¶ 100, 104.


135.    We conclude the owners of Lost Cabin are not “other parties” as that statutory term has been interpreted by this Board and the Wyoming Supreme Court. While “other parties” need not be arms-length, third parties to fulfill the statutory requirement, the term clearly anticipates something more than a group of entities and individuals collectively owning a gas plant and agreeing to share the cost and expense of constructing, expanding, maintaining, and operating the plant as is the situation with Lost Cabin. BP America Production Company v. Department of Revenue, 2005 WY 60, ¶¶ 21, 22, 112 P.3d at 607; Union Pacific Resources Company, et al., Docket Nos. 2000-147 et al, June 9, 2003, 2003 WL 21774603 (Wyo. St. Bd. Eq.).


136.    The Department’s reliance on BP America, and its interpretation thereof that the Court considered only the Whitney Canyon C&O Agreement to support its conclusion the Lost Cabin plant owners are other parties, is misplaced. The Wyoming Supreme Court, as did this Board, recognized that the Whitney Canyon Gas Plant was operated and treated as an entity separate from each of its producer/owners. Each producer/owner executed a gas processing contract with the plant as a separate and distinct entity, the contract being in addition to the Whitney Canyon C&O Agreement. The Court, contrary to what the Department apparently argues, considered more than just the Whitney Canyon C&O Agreement in reaching the conclusion the producers were “other parties” in their relationship with the plant for purposes of processing gas. The Court noted that there were in fact four separate and distinct contracts between the plant as an entity and the producers whose gas was processed by the plant:

 

Taxpayers are clearly similarly situated producers. They produce gas from the same field and process the gas at the same Plant pursuant to identical processing agreements. Given four identical processing fee agreements, there is no need to further define the terms “quantity” or “quality, terms and conditions.” There is no difference in the agreements as to how the processing fee is determined. When looking for comparable processing fee contracts, one simply cannot get more comparable than four identical contracts. Since finding comparable processing fees is the ultimate goal, that goal is reached if these agreements are truly four separate agreements. FN3

 

FN3 ........ This Court finds that the four identical agreements between four separate producers and the Plant present adequate comparables to enable the Department to fairly estimate Taxpayers' processing costs.


 BP America Production Company v. Department of Revenue, 2005 WY 60, ¶ 20, 112 P.3d at 607-608. See also, Union Pacific Resources Company, et al., Docket Nos. 2000-147 et al, June 9, 2003, 2003 WL 21774603 (Wyo. St. Bd. Eq.).


137.    The contractual relationship between the owners of Lost Cabin is significantly different than the relationship of the owners of Whitney Canyon. As recognized by the Department, the only contractual relationship binding the Lost Cabin plant owners is the C&O Agreement. There are no separate gas processing contracts between the individual producers and the Lost Cabin plant as an entity as is the case with the Whitney Canyon Gas Plant. The Lost Cabin agreement refers to the signatories only as plant owners. Findings, ¶¶ 92, 99, 111.


138.    The testimony presented by Burlington reinforces the conclusion the plant owners did not treat the plant as a separate entity. The intent from the very beginning of discussions with regard to construction of a gas processing plant focused on keeping the plant ownership exclusively in the hands of the well owners, and keeping the plant and well ownership percentages as close to the same as possible. Even when ownership changed in a well with production dedicated to Lost Cabin, the new interest owner became an owner in Lost Cabin. Findings, ¶¶ 8, 19, 21, 44, 45.


139.    The Department’s conclusion the Lost Cabin C&O Agreement and its exhibits, sets forth a processing fee is, as well, not supported by the evidence. The testimony and exhibits presented at the hearing clearly support the conclusion the C&O Agreement is simply a cost sharing arrangement. Such conclusion is supported by the history behind the development of the C&O Agreement in effect for 2005 production.


140.    The original working drafts of the C&O Agreement, which were never presented to the working interest owners in the Madison Formation wells for approval, did in fact contain a fee structure for gas processing services. However, in the first proposed C&O Agreement sent to the working interest owners for approval in July, 1991, as well as the final C&O in place for 2005 production, all mention of processing fees had been removed. The Agreements simply provided the plant owners would pay all plant operating and capital costs. Findings, ¶¶ 11, 12, 13, 22, 33.


141.    The Department, notwithstanding this history and the specific language of the C&O Agreement, still contends the Agreement contains a processing fee consisting of capital expenditures, operating costs, and indirect expenses, including overhead. The Department asserts that Burlington, as plant operator, sending a bill to another owner for that owner’s share of monthly expenses, is the functional equivalent of charging each other owner a processing fee. Such a conclusion finds neither support in the evidence presented with regard to the expenses billed to each owner as compared to what an independent, true “other party” would charge as a processing fee, nor in the language of the Agreement itself. Findings, ¶¶ 96, 98, 100.


142.    A third party, market-based processing fee, the benchmark for use in the comparable value method, would seek to recover more than simply the capital expenditures and operating costs, both direct and indirect including overhead, which are the only costs billed to the respective plant owners. Findings, ¶¶ 23, 24, 28, 30; [Exhibit 915, pp. JT402, JT435, JT436, JT508, JT527].


143.    A market-based fee would seek to recover all of the costs of gas processing, i.e., the operating costs; return of capital spent to build the plant; and a return on capital which might include an increment of profit. The recurring costs of simply running the processing plant are the operating costs. The return of capital spent to build the plant is captured by depreciation. The return on capital is either the interest charged on borrowed money, or the interest income forgone by spending savings. Findings, ¶¶ 60, 61, 62.


144.    The provisions of the C&O Agreement which the Department asserts set forth a processing fee which Burlington might be expected to pay a third-party for gas processing services fail to address three important value elements: the return of capital; the cost of money (return on capital); and a profit element. A rational plant owner would not set a gas processing fee for a non-plant owner based solely on the costs to be billed to the plant owners under the Lost Cabin C&O Agreement. Findings, ¶¶ 60-65, 70, 106, 107.


145.    The terms of the C&O Agreement upon which the Department wishes to rely for use of the comparable value method also do not address another element generally found with third-party, market-based fees. Such fees are commonly based in some manner on gas flowing through the plant for processing, i.e., on throughput. Fees are normally charged based on the volume of gas processed by the plant for each gas producer. The Lost Cabin plant owners are required to reimburse costs under the C&O Agreement whether or not any gas is processed through the plant, a fact which the Department acknowledges. The operating costs billed monthly to each owner can actually even increase if the plant is offline, or operating at minimum capacity due to additional labor and material costs for repairs incurred during the shutdown, or reduced capacity. Findings, ¶¶ 56, 61, 76, 101.


146.    The Department asserts the 12 percent overhead fee added to the monthly joint interest billings under the C&O Agreement supports its conclusion the Agreement provides for a gas processing fee. The evidence presented at the hearing does not support such reasoning. The 12 percent fee is simply an operating cost similar to the other monthly costs. Findings, ¶ 96; [Exhibit 915, p. JT471].


147.    The 12 percent overhead fee was negotiated by the plant owners to allow the plant operator to recover the nonquantifiable, indirect costs of functions such as accounting, tax, computers, and management necessary for the operation of Lost Cabin but performed elsewhere. The fee was not intended, and does not in any manner constitute, a return on or of capital to Burlington as operator. Burlington in fact pays its proportionate share of the fee the same as all other plant owners. Findings, ¶¶ 24, 25, 26, 27, 29, 49, 69.


148.    The objective of the comparable value statute, as this Board has previously stated and the Wyoming Supreme Court has affirmed, and as agreed by the Department, is to determine a reasonable approximation of a processing fee which a taxpayer would be expected to pay a third party to provide gas processing services. The fee should reflect the value added to the gas production by the processing which occurs after the inlet of the gas plant which is the point of valuation. Findings, ¶¶ 102, 106, 107.


149.    The Department asserts the taxable value can be determined for gas processed at Lost Cabin by deducting from each owner’s gas sales the joint interest billings the owner received during the production year. It thus, in effect, equates the value added by processing to the expenses billed each month on the joint interest billings. The Department argues this is a correct conclusion even though it acknowledges the joint interest billings are levied and must be paid whether or not gas is processed through the plant. The Department asserts a processing fee need not be tied to throughput, i.e., the amount of gas being processed through the plant. Findings, ¶¶ 97, 101, 102.


150.    The Department’s conclusion that the sharing by the gas plant owners of operating expenses constitutes a processing fee is not one which the Department has uniformly applied. Grenvik acknowledged in his testimony that the Whitney Canyon plant owners are charged not only a processing fee of 25% of the remnant product, but are also liable for their respective share of planting operating expenses. The Department, however, chose not to include those plant operating costs as part of the processing fee at Whitney Canyon. Findings, ¶ 105.


151.    The conclusion by the Department that the joint interest billing expenses equate to a processing fee is further flawed. The uncontradicted testimony at the hearing makes clear the joint interest billings do not include all costs which one would expect a rational third party processor to include when setting an arms-length processing fee. Even Grenvik testified that a third party would not pay as a processing fee only those plant expenses billed on the joint interest billings. Findings, ¶¶ 64, 65, 67, 70, 107.


152.    The testimony also reveals that use of such a process by the Department could well result in a negative taxable value in years of high capital expenditures or high maintenance costs. Similarly, the Department’s method could not be applied in a manner to amortize capital expenditures over time without disregarding the language of the contract identified by the Department as the source of comparable value. If the Department begins to ignore provisions of a contract on which it is relying for use of the comparable value method, it may be heading in the direction of proposing a mutually agreeable alternative method.


153.    The capital costs incurred in plant additions and other capital projects, as well as operating expenses, are billed monthly to each plant owner, and each is expected to pay those costs as billed. Thus, for example, the capital costs for Train #3 at Lost Cabin were billed as the train was being built. When it went online in September, 2002, most if not all of the capital expenses associated with its construction had been billed and paid. As a result, if the Department had attempted to determine a taxable value by simply deducting joint interest billings from gross revenues net of exempt royalties, the costs billed for the production years 2000, 2001, and 2002, when Train #3 was being built, would render, in the aggregate, a negative taxable value. Such a result would also be in violation of basic accounting principles. Findings, ¶¶ 67, 87, 88, 89.


154.    Burlington has overcome the presumption in favor of the Department’s valuation of the Lost Cabin 2005 gas production, and has as well fulfilled its burden of ultimate persuasion that the Department’s use of what it has characterized as the comparable value method to value the 2005 Lost Cabin gas production was not in accord with the statutory requirements for valuing state-assessed property. Conclusions, ¶¶ 115, 122.


155.    The Department did not find reliable information about processing fees paid by other taxpayers from which it could make reasonable inferences as to Burlington’s processing costs for its 2005 production.


156.    The Department’s desire, as stated by Grenvik during the hearing in this matter, to “fend off” assertions made in other cases that it was treating other producers unfairly as compared to Burlington by using the comparable value method for the production processed through Lost Cabin in 2005 has also been addressed by the Wyoming Supreme Court:

 

The DOR directed all producers to use the comparable value method to value their production unless there were no comparables. Simply because the DOR was unable to apply the comparable value methods to a few producers because of a lack of appropriate information does not mean it was inequitable to apply the comparative value method to Chevron when there were comparables for the Carter Creek plant. There is no basis for finding Chevron was subjected to taxation in violation of its equal protection rights.


Chevron U.S.A., Inc. v. Department of Revenue, State of Wyoming, 2007 WY 79, ¶ 35, _____ P.3d _____ (2007 WL 1377890)(2007). Facts, ¶ 108.


157.    Burlington, in its appeal to this Board, also challenged the ability of the Department to use a different valuation method, i.e., comparable value, to value 2005 production after approving Burlington’s use of proportionate profits to report production years 2003, 2004, 2005. Our conclusion that the comparable value method can not be used by the Department to value the production processed through Lost Cabin in 2005 renders moot the question of whether the Department could properly use a different valuation method than the one which it approves for a taxpayer’s use during the three-year selection cycle. We note nevertheless that the method identified by the Department pursuant to Wyo. Stat. Ann. §§ 39-14-203(b)(vi) & (b)(viii) for production years 2003, 2004, and 2005, was comparable value. Burlington was allowed to deviate from the selected method based on its attestation that no comparable value existed for Lost Cabin production for the years in question. The use by Burlington of the proportionate profits method to value 2003, 2004, and 2005 production was thus an exception to the selected comparable value method. And while the Department clearly reserved its right to return, after further investigation, to the originally selected method as the appropriate valuation method, the exercise of such right in this matter was not appropriate. Findings, ¶ 75; [Exhibits 901, 902, 903].



ORDER


           IT IS THEREFORE HEREBY ORDERED the Department of Revenue application of the comparable value method to value the Lost Cabin 2005 production is reversed.


Pursuant to Wyo. Stat. Ann. § 16-3-114 and Rule 12, Wyoming Rules of Appellate Procedure, any person aggrieved or adversely affected in fact by this decision may seek judicial review in the appropriate district court by filing a petition for review within 30 days of the date of this decision.


           DATED this day of May, 2007.


                                                                  STATE BOARD OF EQUALIZATION



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                                                                  Alan B. Minier, Chairman



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                                                                  Thomas R. Satterfield, Vice-Chairman



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ATTEST:                                                 Thomas D. Roberts, Board Member


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Wendy J. Soto, Executive Secretary