Accounting Concepts Applicable to Federal Royalty Analysis of the Processing Allowance Formula

Although the MMS has finally codified the costs which will be included in the calculation of the processing allowance,1 a significant portion of the formula is not included within the regulations and must be extrapolated from the guidelines which the MMS has issued and which will be incorporated into the MMS payor handbook.2

The manner in which the MMS intends to implement the new processing formula will significantly impact a lessee with an ownership in a plant which processes nonowner production and a lessee with an ownership in an extraction plant which does not contain the fractionation facility therein.

Although there are other possible results, there are two key areas in which the allocation by the MMS of expenses and other data furnished by the lessee significantly impacts the resulting formula:

1.Whether expenses are allocated to income attributable to the plant owners in calculating the processing allowance or whether expenses are allocated to production on a per unit basis.

2.Whether the fractionation allowance attributable to a plant geographically distinct from the extraction facility is proportionately reduced by the manufacturing allowance attributable to the extraction plant.

II. THE PROCESSING ALLOWANCE — EXTRACTION AND FRACTIONATION.

The processing allowance is recognized by the MMS as “quite frequently the