REGULATORY: U.S. Regulatory: As Coal Exports Hit Record Highs, Interior Inspector General Questions Lease Valuations

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Even as U.S. coal exports surge to record highs,[1] the Bureau of Land Management (BLM) is being taken to task for (among other items) failing to take account of the burgeoning export market when calculating the fair market value (FMV) of federally owned coal.

The Inspector General of the Department of the Interior recently issued an evaluation of the Department's coal mining activities on federal land that are overseen by BLM (the "Report").[2] Among the objectives of the Report, the Inspector General investigated whether Interior's coal leasing process obtains a fair return for the public's coal.
The Report's findings critiqued the manner in which the BLM manages the coal program, noting certain "weaknesses" in the lease sale process that put the government "at risk of not receiving full value for coal leases." The Report called out in detail weaknesses involving processes for determining the FMV for coal leases and determining lease modifications.

The Valuation Process

As outlined in the Report, prior to each competitive coal lease sale, BLM estimates the FMV of the property. The FMV is based on BLM's assessment of projected income to a coal mining company, an analysis of comparable, prior lease sales, as well as economic, geologic, and engineering variables unique to each proposed mining operation. Some of these variables include the price of coal; current and future demand for coal; market conditions; shipping costs; proximity of the mine to available transportation and an end market; quality of the coal, which includes energy content and impurities such as ash and sulfur; depth of coal seams; equipment and labor required to operate the mine; and whether the coal would be extracted by surface or underground mining methods.

According to the Report, the export potential of coal is notably absent from the list of variables weighed by BLM. Despite the fact that the price of exported coal more than doubled between 2007 to 2011, and that 2012 exports of coal totaled over 125 million tons (more than twice 2007 totals), the Report notes that only one state office routinely calculated FMV with the potential for exporting as a consideration. Evaluators concluded that most state offices overlook the export potential of coal, thus possibly undervaluing the FMV of the lease.

To that end, evaluators identified $60 million in potentially undervalued lease modifications that occurred, in part, due to inconsistent valuation practices. The Report noted that a 1-cent-per-ton undervaluation in the FMV calculation for a sale can result in millions of dollars in lost lease sale revenues, an assertion supported by the sheer tonnage of coal produced from federal and Indian lands, which totaled 473 million tons in 2011.[3]

Recommendations

The Report recommended changes to BLM's processes for valuation and acceptance of bids on federal coal lease sales. BLM was urged to follow established procedures documented in Interior's Department Manual and work with Interior's Office of Valuation Services in preparing FMV appraisals. The Report noted that Valuation Services maintains particular expertise in mineral valuation, a complex and unique field of appraisal, and serves as Interior's "authority on valuation for all minerals extracted from public lands." BLM was also encouraged to account fully for the export potential in developing coal FMVs.

Bidding Process

Weighing the valuation factors, BLM computes a FMV for the lease, which is kept secret, and publicly announces a sale. Since many leases offered for sale receive limited bids, and BLM is prohibited by statute from accepting a bid that is less than the established FMV, BLM's determination of this value often is the critical driver in whether a successful sale is held.

The Report also noted that procedures for accepting the winning bid at a lease sale are not consistent among BLM state offices. According to the Report, these inconsistencies are most prevalent in situations involving unsuccessful lease sales. In some state offices, if a bid does not meet or exceed the FMV, the office rejects the bid and holds a "reoffer" (including repeating administrative actions such as reassessing the FMV and publishing Federal Register notices). Other state offices allow companies to provide information to justify their original bids, a practice that the Report says led to the acceptance of bids below the established FMV. Evaluators identified lost bonus revenues of $2 million in recent lease sales because BLM accepted bids that were below the established FMV, a violation of provisions of the Mineral Leasing Act.

Recommendations

Evaluators suggested that BLM reject bids less than the established FMV in compliance with the Mineral Leasing Act and explore options for a more efficient lease reoffer process in instances when initial bids fail to meet the established FMV.

Royalty Rate Reduction

BLM permits companies to request a reduction in royalty rate if a mine becomes unprofitable because of adverse geologic conditions or financial hardship. If BLM considers a request justified, a royalty rate may be reduced to as low as two percent of sales value. Reductions are granted on a temporary basis and may expire after a designated period, when a specified volume of coal has been mined, or when mining operations cease.

Evaluators noted that when a royalty rate reduction is based on financial hardship, BLM coal program officials, who are mostly trained in geology and mine engineering, may not have the expertise to evaluate a company's financial statements and supporting documentation. In these cases, the Report noted that the Department's Office of Natural Resources Revenue (ONRR) officials, who have accounting expertise in financial record analysis, could provide important assistance to BLM.

Recommendation

The Report encouraged BLM to work with ONRR when processing applications for royalty rate reductions that are based on financial hardship grounds.

Perspective

The Report recommendations should be viewed in light of an average lease sale price of $320 million and the $2.4 billion in bonuses and royalties collected by the government from coal mining activities on federal and Indian lands in FY 2012. As we noted in March,[4 ] there is a push by some in the 113th Congress to exercise more stringent oversight of federal mineral royalties beyond traditional oil and gas targets; it is almost certain that the content of the Inspector General's report will be considered while weighing possible coal royalty reforms.

The Government Accountability Office (GAO) is expected to issue a separate report on the Department's coal leasing program this summer.
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[1] U.S. coal exports set monthly record, U.S. Energy Information Administration, 2013, available at www.eia.gov/todayinenergy/detail.cfm?id=11751#.
[2] Final Evaluation Report – Coal Management Program, Report No. CR-EV-BLM-0001-2012, U.S. Department of the Interior, Office of the Inspector General, U.S. Department of the Interior, June 11, 2013, available at www.doi.gov/oig/reports/upload/CR-EV-BLM-0001-2012Public.pdf.
[3] Id. at 3.
[4] A Decade's Worth of Coal Sales to be Scrutinized by Interior, Senate, King & Spalding Energy Newsletter, March, 2013, available at www.kslaw.com/library/newsletters/EnergyNewsletter/2013/March/article3.html

 

Jeffrey H. Perry
Washington, DC
+1 202 626 5521

jperry@kslaw.com
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