1. PASO Federal/Indian Royalty Compliance Workshop February 11-12, 2015
Federal Royalty Unbundling Information Presented by: Doug Ginley and Linda Shishido-Sheahan
PASO Federal/Indian Royalty Compliance Workshop
February 11-12, 2015
Industry Compliance
Accurate Revenues & Data
Professionalism & Integrity

2. In This Presentation
ONRR’s Unbundling Program
The “basics” of Unbundling
ONRR’s Engineering Solution
ONRR’s Unbundling Strategy
Answers to industry questions

3. Unbundling is Important to ONRR!
ONRR has received special funding for an unbundling program. ONRR’s funding includes:
18 FTE for the program
Purchase of Industry Accepted Engineering Software
ONRR is working on the unbundling of over 35 gas plants and transportation systems
ONRR has already published Unbundling Cost Allocations (UCAs) for 17 gas plants/transportation systems. UCAs may be found at

4. Unbundling is Important to ONRR!
ONRR continues to present information on the Unbundling process to a wide array of companies and industry groups
ONRR is implementing a new streamlined process for compliance activities
ONRR is coordinating its new unbundling strategy with State and Tribal audit programs

5. What is Unbundling?
Unbundling = the process of taking a gas transportation and/or processing fees, in an ARM’S-LENGTH situation, and determining the allowed and disallowed costs for Royalty Reporting and Payment. Includes:
Determining marketable condition
Separating the Transportation Fees from Processing Fees
Applying the appropriate Unbundling Cost Allocations (UCAs)* to the fees you are charged for transportation, gathering, compression, dehydration, treatment, and processing
*Note: A UCA is the percent of a fee that is allowable (there will likely be a different percentage for Transportation and Processing)

6. Unbundling Program Status Update
Updates to the Website
UCAs
Examples
More Guidance Information
Compliance Reviews and Audits
Requests for Data
Responding to Requests for Information

7. Unbundling Efforts as a
Percent of Gas Volume

8. How do we decide which plants to look at?
Gas Plant Prioritization
How do we decide which plants to look at?
Cover 80% of production volumes*
Variety of locations to represent gas industry
Diverse set of owners/operators
Leverage available data
Subject to change dependent on ONRR’s ability to collect sufficient data for analysis
*Based on FY 2013 data

9. 2014 U.S. Dist. LEXIS 100900, *20 (N.D. Okla. July 24, 2014)
Burlington Decision
(Burlington Res. Oil & Gas Co. Lp v. United States DOI, No. 13-CV-0678-CVE-TLW,
2014 U.S. Dist. LEXIS , *20 (N.D. Okla. July 24, 2014) 
What the Burlington Decision means:
You must show any costs you deduct were incurred only to transport and process the gas and were not necessary to place your gas in marketable condition (i.e. Unbundling)
Lessees have the burden of establishing that gas is in marketable condition and where that occurs
The marketable condition rule applies to POP contracts

10. What Does ONRR Expect of Industry?
Properly Report and Pay Royalties
Correctly calculate transportation and processing allowances – this means UNBUNDLING
Calculate your own UCAs using a reasonable method
Alternative 1 – Use ONRR UCAs if available
Alternative 2 – Take no allowance

11. Reasonable Unbundling Effort?
What Counts as a
Reasonable Unbundling Effort?
A reasonable effort includes providing ONRR with:
The applicable transportation systems and processing plants
Specific marketable condition requirements
Inlet/outlet conditions for major equipment including (but not limited to) compression, dehydration, CO2 removal, and H2S removal
Allowed and disallowed fee portions through a clearly explained methodology of unbundling (see ONRR Unbundling website for examples)
Supporting documentation 11

12. The Unbundling Process
START
Identify Gas Plant and Transportation Systems
Determine Marketable Condition
Collect the Data
Identify Data Needs
Calculate the Unbundling Cost Allocations (UCAs)
Apply the Unbundling Cost Allocations (UCAs) 12
END
Report and Pay Royalties Correctly

13. More Information on the Unbundling Process

14. The Unbundling Process (a quick look)
START
Identify Gas Plant and Transportation Systems
Determine Marketable Condition
Collect the Data
Identify Data Needs
Calculate the Unbundling Cost Allocations (UCAs)
Apply the Unbundling Cost Allocations (UCAs) 14
END
Report and Pay Royalties Correctly

15. An Example of Unbundling Determine Allowed/Disallowed Equipment
Use physical properties to determine Allowed/Disallowed Equipment
Marketable Condition
800 PSIA
7 # H2O
2% CO2
100 PSIA
20 # H2O
8% CO2
400 PSIA
20 # H2O
8% CO2
400 PSIA
10 # H2O
8% CO2
900 PSIA
10 # H2O
8% CO2 X X
X 8/9 C1 D C2
TO MAINLINE
CDP
GAS PLANT
TRANSPORTATION
WELLS
CDP = Central Delivery Point
PROCESSING C
= Compressor D
= Dehydrator

16. An Example of Unbundling Determine Allowed/Disallowed Equipment
Use physical properties to determine Allowed/Disallowed Equipment
300 PSIA
Bone Dry
2% CO2
Wet Gas
700 PSIA
10 # H2O
2% CO2
800 PSIA
Bone Dry
2% CO2
400 PSIA
10 # H2O
8% CO2
CO2
Residue Gas X C4
900 PSIA
10 # H2O
8% CO2
Allowed C3 X
AMINE Treating
Allowed
To Main Line
Cryo Unit
Dry Gas
800 PSIA
7 # H2O
2% CO2
Oil Liquids
NGLs
X 3/10
800 PSIA
10 # H2O
8% CO2
Dehydration
600 PSIA
Bone Dry
2% CO2
Plant Boundary
Water

17. Calculate Unbundling Cost Allocations (UCAs)
Transportation System
Processing Plant
Equipment
Cost
(millions of dollars)
Allowed Cost
Compressor 3 5
Amine Treating 2
Dehydration 1
0.7*
Cryo Unit 10
Compressor 4
Piping and other allowed equipment 35
Total 58
50.7
Equipment
Cost
(millions of dollars)
Allowed Cost
Compressor 1 15
Dehydrator 3
Compressor 2
1.67*
Pipeline 50
Total 83
51.67
* = (1-8/9)*15
Transportation UCA = 51.67/83 = 62%
* = (1-3/10)*1
Processing UCA = 50.7/58 = 87%
Separating Transportation from Processing:
Transportation percent = $83M/($83M+$58M) = 59%
Processing Percent = 100% - 59% = 41%

18. Calculating Allowed Transportation and Processing
Assume your bundled fee is $1.00/MMBtu
Allowed Transportation Fee
Transportation portion of bundled fee = 59%
Transportation fee = $1.00 * 0.59 = $0.59/MMBtu
Transportation UCA = 62%
Allowed Transportation fee = $0.59 * 0.62 = $0.37/MMBtu
Allowed Processing Fee
Processing portion of bundled fee = 41%
Processing fee = $1.00 * 0.41 = $0.41/MMBtu
Processing UCA = 87%
Allowed Processing fee = $0.41 * 0.87 = $0.36/MMBtu

19. The Unbundling Process
But what if you don’t have the cost data?

20. ONRR’s Engineering Solution
ONRR is implementing an Engineering Solution that uses:
Industry-accepted engineering practices and data
Sophisticated, “Industry Standard” computer modeling tools
Replacement costs, adjusted for location, updated annually

21. ONRR’s Engineering Solution
You too can use an Engineering Solution!
An Engineering Solution has minimal data needs:
Process flow diagrams
Gas throughput
Gas composition
Inlet and outlet conditions for major process components

22. ONRR’s Engineering Solution
Engineering Drawings
Aspentech Software Suite
Equipment Specifications
Hypothetical Gas Plant
Gas Specifications
Replacement Cost Data
Engineering Principles
Unbundling Cost Allocations (UCAs)

23. UCA Comparison Aspen to Reasonable Actual Cost Comparison:
UCAs for allowed cost:
Aspen UCA
Actual Cost UCA
Difference
T %
64.9%
4.4%
T %
73.9%
3.3%
P %
27.8%
0.6%
Note: Work is underway to verify Aspen model results with multiple transportation systems and gas plants.

24. ONRR’s Unbundling Strategy
Publish UCAs for high priority gas plants and transportation systems
Respond to industry inquiries
Perform limited scope compliance reviews (transportation and processing allowances)
Perform Transportation and Processing Audits – Review reasonable actual costs

25. FY 2015 Unbundling Work
* OG = Offshore Gulf

26. FY 2015 Unbundling Work
* OG = Offshore Gulf

27. Limited Scope Compliance Reviews
If you are claiming a bundled fee that includes costs to place gas into Marketable Condition, you must:
Unbundle – submit methodology & documentation to the Unbundling Mailbox/Analyst*
Correct and pay on all properties flowing to that plant for all sales months where you took a bundled fee
* Unbundled Fees may be subject to review and audit

28. Limited Scope Compliance Reviews
As an Alternative Method:
Use published UCAs if available where you must correct and pay:
Per the invoice for all sample months
On all properties flowing to that plant for all non-sample sales months where you took a bundled fee*
* Unbundled Fees may be subject to review and audit

29. Limited Scope Compliance Reviews
Take no allowance where you must correct and pay:
For sales months during the review period
On all properties flowing to that plant for all sales months prior to, and after the review period, where you took a bundled fee

30. Resolution Process
If not resolved at the Issue Letter stage, ONRR will issue an Order
You must comply with the Order or Appeal
You must file a Notice of Appeal and a statement of reasons or written arguments justifying a reversal or modification of the Order within 30 days of receiving the Order
You cannot extend the time allowed for filing the Notice of Appeal

31. Transportation and Processing Audits
Perform Transportation and Processing Audits to review reasonable actual cost (Non-Arm’s-Length)
Verify allowed processing rate per unit cost
Verify allowed transportation rate per unit cost
Calculate UCAs based upon reasonable actual cost and use these UCAs to validate ONRR’s engineering solution

32. The ONRR Unbundling website is at: 32

33. Communicating with the Unbundling Team
For questions, requests, and submitting methodologies/documentation regarding unbundling,

34. Communicating with the Unbundling Team
Contact Information
Doug Ginley
Linda Shishido-Sheahan

35. Industry Questions
Has ONRR accepted any alternative unbundling methodologies?
Some are in the review process now. With ONRR’s compliance strategy, we anticipate more alternative methods from industry
Would ONRR consider a “virtual” plant typical for an area in lieu of unbundling actual plants? 
Provided you can demonstrate why this approach is reasonable, we would consider it

36. Industry Questions Who can use the ONRR posted UCA’s ?
Arm’s-Length producers
In ONRR’s “How to calculate a Transportation UCA”, why is the denominator for the allocation of compression the discharge pressure of the compressor? 
This is a continuation of ONRR’s Marketable Condition policy
Shouldn’t the pressure drop from one compressor to the inlet of the next compressor be identified as allowable transportation costs? 
Not under the current ONRR Marketable Condition policy

37. Industry Questions
If the lessee is paying for the cost of boosting the residue, why do ONRR examples also require the lessee to pay for the compression up to mainline pipeline specs prior to it being processed?   
Lessee must place gas in marketable condition (30 C.F.R. § (i) (federal gas), § (h) (Indian gas))
The fact that a marketable condition cost also may be part of processing does not make it a deductible processing cost Shoshone & Arapaho Tribes v. Hodel, 903 F.3d 784 (10th Cir. 1990)
Lessees may not deduct the costs for boosting residue gas, i.e., compression of the methane, at a gas processing plant. 30 C.F.R. § (b) (federal gas)(Devon)

38. Industry Questions
Are the costs of the booster compressor to be allocated to the gas used for “reflux” (typically 20-35%) and residue sales volumes, with the portion of costs applicable to the “reflux” taken as part of the processing allowance?
Lessees may not deduct the costs for boosting residue gas, i.e., compression of the methane, at a gas processing plant. 30 C.F.R. § (b) (federal gas)(Devon)

39. Industry Questions
Should not all the pre-plant compression and related fuels be deductible for the NGL portion of the gas stream or have a different UCA rate than the residue gas?
No, the entire gas stream is being compressed
What meters are allowed and which ones are not, and why are they not an allowable deduction?
Per case law: The 1998 Williams Production Company case (signed by the Acting Deputy Commissioner of Indian Affairs) follows the Handbook and allows the deduction of meters within processing plants

40. Industry Questions
Are low or minimum volume fees an allowable deduction? 
We do not participate in pipeline penalties. (30 C.F.R. § (g)(3))
Has ONRR decided to unbundle fractionation plants?
This question is currently under review

41. QUESTIONS Industry Compliance Accurate Revenues & Data
Professionalism & Integrity