     Case: 10-20729     Document: 00511641536         Page: 1     Date Filed: 10/21/2011




            IN THE UNITED STATES COURT OF APPEALS
                     FOR THE FIFTH CIRCUIT  United States Court of Appeals
                                                     Fifth Circuit

                                                                            FILED
                                                                         October 21, 2011

                                       No. 10-20729                        Lyle W. Cayce
                                                                                Clerk

CITATION OIL & GAS CORPORATION,

                                                  Plaintiff - Appellant
v.

UNITED STATES DEPARTMENT OF THE INTERIOR,

                                                  Defendant - Appellee



                   Appeal from the United States District Court
                        for the Southern District of Texas
                             USDC No. 4:08-CV-01977


Before KING, GARZA, and GRAVES, Circuit Judges.
PER CURIAM:*
        This suit involves a dispute regarding the royalties owed by Plaintiff-
Appellant Citation Oil & Gas Corporation under its oil and gas leases of federal
land in North Dakota. The Minerals Management Service, a subagency of
Defendant-Appellee the United States Department of the Interior, ordered
Appellant to pay additional royalties based on an audit conducted by the North
Dakota Office of the State Auditor. Appellant alleges that Appellee made
numerous errors in calculating the royalties due, arguing that Appellee

        *
         Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH CIR.
R. 47.5.4.
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improperly applied the marketable condition rule, erred by denying it a
transportation allowance, relied on flawed data and methodology, and failed to
disclose sufficient information for Appellant to challenge Appellee’s findings.
After a series of administrative appeals rejecting Appellant’s challenges, the
district court granted summary judgment in favor of Appellee. We affirm the
judgment of the district court.
             I. FACTUAL AND PROCEDURAL BACKGROUND
       Plaintiff-Appellant Citation Oil & Gas Corporation (“Citation”) leases
federal land in North Dakota from Defendant-Appellee the United States
Department of the Interior (“Interior”). At all times relevant to this dispute,
Citation transferred natural gas to Koch Hydrocarbon Company and its
successor Bear Paw Energy (collectively, “Koch”) under various processing
contracts. Pursuant to these contracts, Koch gathered Citation’s unprocessed
casinghead gas at or near Citation’s wells and transferred the gas to Koch’s
processing plant over forty miles away. Koch then processed the casinghead gas,
yielding dry gas and gas byproducts, including sulfur and liquid hydrocarbons.
Koch paid Citation a percentage of the proceeds Koch received from selling the
dry gas and gas byproducts, less the costs attributable to treating and
compressing Citation’s gas and the costs for electricity related to processing the
gas.
       Under the terms of its leases of federal land, Citation was required to pay
royalties on the oil and natural gas it extracted. The North Dakota Office of the
State Auditor (the “State Auditor”) conducted an audit of Citation’s royalty
payments on the leases at issue.1 The audit covered Citation’s royalty payments
from October 1, 1996, through December 31, 1999, and January 1, 2000, through
April 30, 2002. The State Auditor sent Audit Issue Letters to Citation on March

       1
        Under 30 U.S.C. § 1735(a)(1), the Secretary of the Interior may delegate the
responsibility to conduct audits “to any State with respect to Federal land within the state.”

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18, 2003, and August 7, 2003, describing its findings and informing Citation that
Citation could provide documents or comments to refute the State Auditor’s
determinations.     In timely responses to these letters, Citation expressed
disagreement with the State Auditor’s findings but did not provide any
additional documentation to support its position. Based on the audit, the
Minerals Management Service (“MMS”),2 a subagency of Interior, issued two
orders on November 22, 2003, requiring Citation to report and pay additional
royalties because, among other things, it found that Citation had based its
royalty payments on amounts that reflected improper deductions of fees for gas
treatment and compression. Citation appealed the determination of the MMS,
and the Associate Director of Policy and Management Improvement (the “MMS
Director”) denied Citation’s appeal. Citation appealed the MMS Director’s
determination to the Interior Board of Land Appeals (“IBLA”), which affirmed
the MMS Director’s decision. Citation then appealed the decision of the IBLA
to the United States District Court for the Southern District of Texas, where
both parties filed motions for summary judgment. The district court granted
summary judgment in favor of Interior, and Citation now appeals the district
court’s decision.
                               II. DISCUSSION
      We review the grant of summary judgment de novo and apply the same
standard as the district court. Freeman v. Quicken Loans, Inc., 626 F.3d 799,
801 (5th Cir. 2010). We review the appeal of an administrative agency’s decision
under the Administrative Procedure Act, which provides that a “reviewing court
shall . . . set aside agency action, findings, and conclusions found to
be . . . arbitrary, capricious, an abuse of discretion, or otherwise not in
accordance with the law” or “unsupported by substantial evidence.” 5 U.S.C.

      2
        MMS was renamed the Bureau of Ocean Energy Management, Regulation, and
Enforcement, effective June 18, 2010.

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§ 706(2)(A), (E). “[T]he standard of review is thus highly deferential to the
administrative agency whose final decision is being reviewed[,] and a court
‘should not substitute [its] own judgment for the agency’s.’” Tex. Clinical Labs.,
Inc. v. Sebelius, 612 F.3d 771, 775 (5th Cir. 2010) (final alteration in original)
(quoting F.C.C. v. Fox Television Stations, Inc., 129 S. Ct. 1800, 1810 (2009)). An
agency’s “determinations as to purely legal questions are reviewed de novo.”
Alwan v. Ashcroft, 388 F.3d 507, 510 (5th Cir. 2004).         Courts “must give
substantial deference to an agency’s interpretation of its own regulations,” giving
the agency’s interpretation “controlling weight unless it is plainly erroneous or
inconsistent with the regulation.” Thomas Jefferson Univ. v. Shalala, 512 U.S.
504, 512 (1994) (citation and internal quotation marks omitted). “This broad
deference is all the more warranted when . . . the regulation concerns a complex
and highly technical regulatory program . . . .” Id. (citation and internal
quotation marks omitted).
A. Statutory and Regulatory Framework
      The Secretary of the Interior has the authority to lease federal lands for
oil and gas exploration and to enforce mineral leasing laws on federal lands. See
30 U.S.C. §§ 226(a), 1701. Lessees pay royalties based on the value of the oil and
gas extracted from the federal lands. Under Interior’s rules for calculating
royalties, unprocessed gas includes “all gas where the lessee’s arm’s-length
contract for the sale of that gas prior to processing provides for the value to be
determined on the basis of a percentage of the purchaser’s proceeds resulting
from processing the gas.” 30 C.F.R. § 1206.152. The value of unprocessed “gas
sold under an arm’s-length contract is the gross proceeds accruing to the lessee,”
less “applicable allowances.” 30 C.F.R. § 1206.152(a)(2), (b)(1). “Gross proceeds”
is defined as “the total monies and other consideration accruing to an oil and gas
lessee for the disposition of unprocessed gas, residue gas, or gas plant products
produced.” 30 C.F.R. § 1206.151. The Interior’s rules set out various allowances

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that permit a lessee to deduct certain transportation, processing, and operating
costs from its gross proceeds when calculating royalties.           See 30 C.F.R.
§§ 1206.156–160. Thus, these allowances function to reduce the amount of
royalties the lessee owes. Under the marketable condition rule, however, a
lessee may not deduct costs incurred to place gas in marketable condition.
Pursuant to the rule,
      [t]he lessee must place gas in marketable condition and market the
      gas for the mutual benefit of the lessee and the lessor at no cost to
      the Federal Government. Where the value established under this
      section is determined by a lessee’s gross proceeds, that value will be
      increased to the extent that the gross proceeds have been reduced
      because the purchaser, or any other person, is providing certain
      services the cost of which ordinarily is the responsibility of the
      lessee to place the gas in marketable condition or to market the gas.

30 C.F.R. § 1206.152(i). Gas in marketable condition is “sufficiently free from
impurities and otherwise in a condition that [it] will be accepted by a purchaser
under a sales contract typical for the field or area.” 30 C.F.R. § 1206.151. The
Secretary of the Interior is required to “audit and reconcile, to the extent
practicable, all current and past lease accounts for leases of oil or gas and take
appropriate actions to make additional collections or refunds as warranted.” 30
U.S.C. § 1711(c)(1).
B. Marketable Condition
      As discussed above, a “lessee must place gas in marketable condition and
market the gas for the mutual benefit of the lessee and the lessor at no cost to
the Federal Government.” 30 C.F.R. § 1206.152(i). This court has stated that,
under the marketable condition rule, “marketing costs cannot be deducted from
the gross proceeds, equal to the value of production, before royalty is calculated.”
Mesa Operating Ltd. P’ship v. U.S. Dep’t of Interior, 931 F.2d 318, 325 (5th Cir.
1991) (emphasis omitted). Citation argues that it sold unprocessed gas to Koch
and that this gas was already in marketable condition. Thus, according to

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Citation, the price Koch paid to Citation was the appropriate amount upon
which to base its royalty payments to Interior. Interior, on the other hand,
maintains that the costs of treatment and compression were incurred to put the
gas in marketable condition and therefore should not have been deducted from
Citation’s gross proceeds when calculating royalties. Interior stresses that the
agreements between Citation and Koch were processing contracts under which
Citation was paid a percentage of the proceeds of Koch’s sales of the dry gas and
gas byproducts. Citation was paid only when Koch sold the gas and gas
byproducts, and the amount Citation was paid could not be determined until
such sale was made. Further, the amount paid to Citation was reduced by a
share of the costs for treatment, compression, and electricity. As a consequence,
Interior concluded that Citation’s royalty payments should have been based on
the amount Citation received from Koch plus Citation’s share of the fees
incurred for treatment and compression, which Interior determined were
required to put the gas in marketable condition.
      Citation argues that a 1991 amendment to the Interior’s regulations made
the marketable condition rule inapplicable to unprocessed gas sold as feedstock
under percentage-of-proceeds contracts. Interior contends that Citation waived
this argument by failing to raise during proceedings at the administrative level.
We agree that, on the record in front of us, it appears Citation did waive this
argument by failing to raise it until its appeal to the district court. However,
regardless of whether a waiver occurred, we find that the amendment on which
Citation relies does not render Interior’s application of its valuation standards
arbitrary or contrary to law. See Revision of Valuation Regulations Governing
Gas Sales Under Percentage-of-Proceeds Contracts, 56 Fed. Reg. 46,527, 46,529
(Sept. 13, 1991) (stating that the revision was not expected to “result in a change
in royalty collections” and that “gross proceeds may not be the measure of value
for royalty purposes when the gas is not sold in marketable condition”). We

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defer to Interior’s interpretation of its valuation standards on this point. See
Rodriguez-Barajas v. Holder, 624 F.3d 678, 679–80 (5th Cir. 2010) (“We defer to
an agency’s interpretation of its own regulation unless an alternative reading is
compelled by the regulation’s plain language or by other indications of the
Secretary’s intent at the time of the regulation’s promulgation.”) (citation and
internal quotation marks omitted).
      We find that Interior’s conclusion that compression and treatment costs
should not have been deducted from Citation’s proceeds was not arbitrary and
should not be set aside. As the district court observed, the price paid to Citation
for its casinghead gas was “not based on some index price for casinghead gas.
Thus, Citation’s contention that the gas clearly was ‘marketable,’ because
someone bought the gas is based on the faulty premise that the casinghead gas
was actually purchased for its value as casinghead gas.” Citation Oil & Gas
Corp. v. U.S. Dep’t of Interior, 4:08-CV-01977, at 6 (S.D. Tex. Sept. 13, 2010). In
light of the fact that Citation’s gas was transferred to Koch under processing
agreements, as well as the fact that Citation was paid based on Koch’s sales of
Citation’s dry gas and gas byproducts, it reasonably follows that the compression
and treatment costs (which were borne, at least in part, by Citation by virtue of
the adjustments for costs made by Koch) were incurred to place the gas in
marketable condition.     Thus, the district court properly granted summary
judgment in favor of Interior regarding Citation’s improper deduction of costs
incurred to place its gas in marketable condition.
      Citation also argues that it should have been given processing allowances
for the recovery of sulfur and that removal was not necessary to put its gas in
marketable condition. However, as the district court noted, this issue is moot
because Interior granted Citation a processing allowance for sulfur. Citation,
4:08-CV-01977, at 6. The court also correctly noted that Citation waived this
argument by failing to raise the issue prior to the appeal to the district court.

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Id. at 6 n.2 (citing Dep’t of Transp. v. Public Citizen, 541 U.S. 752, 764–65
(2004)).
C. Transportation Allowance
      Citation argues that it is entitled to a transportation allowance that would
eliminate or greatly reduce the amount of additional royalties it owes. As
discussed above, Interior’s rules provide for the deduction of transportation costs
from the amount upon which royalties are based under certain circumstances.
See 30 C.F.R. § 1206.156. Interior’s rules set out a procedure for seeking a
transportation allowance and require a lessee to claim “a transportation
allowance by reporting it” on a specified form. 30 C.F.R. § 1206.157(a)(1)(i).
Citation, however, never filed the appropriate form requesting the allowance.
Similarly, Citation failed to assert any entitlement to such an allowance until
its appeal to the IBLA. Citation argues that it was nonetheless entitled to a
transportation allowance by virtue of its assertions before the IBLA. Citation
contends that an audit should aim to correct both underpayments and
overpayments and that the denial of a transportation allowance would run
contrary to 30 U.S.C. §§ 1721 and 1721a, which permit a party to request a
refund during an audit. Interior, on the other hand, maintains that adherence
to the procedural requirements for seeking a transportation allowance was
required.    Interior further asserts that Citation failed to demonstrate its
entitlement to a transportation allowance and has noted that it would be forced
to search Citation’s records to determine whether any such allowance was
proper.     As the district court observed, although “MMS must give the
transportation allowance when a lessee qualifies,” MMS is not required “to comb
a lessee’s records to determine if that lessee is entitled to a transportation
allowance.” Citation, 4:08-CV-01977, at 7. Consequently, we cannot say that the
IBLA’s decision to hold Citation to the procedural requirements set out in
Interior’s rules was arbitrary and capricious or should otherwise be overturned.

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Thus, the district court’s grant of summary judgment in favor of Interior
regarding the denial of a transportation allowance was proper.
D. Interior’s Use and Disclosure of Data from Exxon
      Citation contends that Interior’s order for additional royalties with regard
to two leases in the Big Stick Unit (“BSU”) was arbitrary and capricious because
the agency relied on flawed data and methodology. Citation further asserts that
Interior acted arbitrarily by failing to disclose sufficient information for Citation
to understand, and potentially challenge, the factual and legal basis of Interior’s
calculations. See Exxon Co., U.S.A., 113 IBLA 199, 205 (1990) (“The recipient
of a decision deserves a reasoned and factual explanation of the rationale for the
decision, and must be given some basis for understanding it and accepting it, or,
alternatively, for appealing and disputing it.”). Citation has the burden of
demonstrating that “the methodology used in the Government’s computation is,
in fact, erroneous.”     BWAB, Inc., 121 IBLA 188, 195 (1991). “Conclusory
allegations of error, standing alone, do not suffice.” United States v. De Fisher,
92 IBLA 226, 227 (1986).
      During the audit of Citation’s royalty payments, the State Auditor
requested documentation from Citation. Citation, however, failed to provide
documentation for two leases in the BSU. Because Citation did not provide the
requested information, Interior relied on receipts from Exxon, the operator of the
unit, for calculations related to these leases. The State Auditor provided
summaries showing the calculations, but Citation asserts that Interior was
obligated to provide the primary source documents on which the calculations
were based.
      Interior notes that Citation did not request the primary source documents
from the State Auditor or Exxon. Further, the IBLA has characterized the
methodology used to calculate the royalties due as relatively straightforward and
easily discernible from the information provided in the letters from the State

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Auditor and the orders that issued on November 2, 2003. In addition, the letters
from the State Auditor clearly indicated to Citation that it could provide such
documents to change the determination that more royalties were owed.
However, as stressed by the district court, “Citation made no effort to supply the
actual records or suggest any alternate method of calculation.”                       Citation,
4:08-CV-01977, at 8–9.
      We conclude that, because Citation failed to provide records that
controvert Interior’s calculation of royalties, the reliance on data from Exxon
with respect to the two leases in the BSU was reasonable. Moreover, in light of
Citation’s failure to request the primary source documents from the State
Auditor or Exxon, as well as the IBLA’s characterization of the relevant
calculations as easily discernible and relatively straightforward, we do not find
that Interior failed to provide a sufficient explanation of its determination that
Citation owed additional royalties under the two BSU leases.
      Citation further argues that Interior’s determination should be set aside
because a subsequent order issued by Interior conflicts with those at issue in this
case. Citation relies on an order issued on September 15, 2008, that, according
to Citation, used data and methodology that conflict with the data and
methodology used by Interior in the calculations in the present dispute.
However, the mere fact that an order—one that issued roughly six months after
the IBLA issued its final decision—might differ from the orders at issue in the
instant case does not demonstrate that Interior acted in an arbitrary manner or
even reached an incorrect result in the instant case.3 Moreover, as the district
court noted, “none of Citation’s arguments explains why Citation did not simply
supply [the] North Dakota [State Auditor] with the proper documentation when
the issue first arose.”        Citation, 4:08-CV-01977, at 9.            In addition, as we


      3
          Citation itself asserts that the order that issued on September 15, 2008, is incorrect.

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discussed above, Citation has not offered its own calculations, provided
supplemental documentation, or otherwise shown that Interior arbitrarily
reached its determination regarding the royalties owed on the BSU leases.
Thus, its argument regarding Interior’s subsequent order is unavailing.
E. Interior’s Use of Estimates
      Finally, Citation asserts that Interior’s use of estimates for the months it
did not audit was arbitrary because Interior had access to actual data. Citation
asserts that courts have rejected attempts by agencies to rely on estimates in
similar situations, but the cases Citation references do not support this position.
See Chem. Mfrs. Ass’n v. EPA, 28 F.3d 1259 (D.C. Cir. 1994); Tex Tin Corp. v.
EPA, 992 F.2d 353 (D.C. Cir. 1993).          Both Tex Tin Corp. and Chemical
Manufacturers Ass’n involved situations in which the agency had relied on
general information or assumptions in the face of specific evidence to the
contrary. Chem. Mfrs. Ass’n, 28 F.3d at 398; Tex Tin Corp., 992 F.2d at 355. As
the district court noted, “[t]he IBLA stated, and the record supports the fact, that
Citation never proffered any other methodology for calculating the total costs.”
Citation, 4:08-CV-01977, at 9–10.       We do not find that       the IBLA acted
arbitrarily by concluding that Citation had not met its burden of showing that
Interior’s methodology was flawed. Consequently, we find that the district
court’s grant of summary judgment in Interior’s favor was proper.
                               III. CONCLUSION
      For the reasons stated above, we AFFIRM the judgment of the district
court granting summary judgment in favor of Interior. Costs shall be borne by
Citation.




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