A widening investigation by the Attorney General and the Department of Natural Resources has produced striking evidence that Antrim natural gas producers may have wrongfully withheld millions more dollars in royalty payments than has yet been made public, according to interviews with state officials and recently released public documents.

In addition, the Michigan Department of the Treasury is analyzing company records to determine whether they underpaid the state severance tax on natural gas production.
The investigations represent the most intensive financial scrutiny the energy industry ever has been subjected to in Michigan.

Atarget of the state probe is Terra Energy, a Traverse-City based subsidiary of CMS Nomeco and the largest producer of Antrim gas. In January Attorney General Frank Kelley filed a lawsuit against Terra to recover $1.4 million in royalty payments that the state asserts the company wrongfully withheld from January 1992 to March 1995, plus more than $900,000 in interest.

For its part, Terra responded with a lawsuit of its own against the state. The company said it has done nothing wrong, and that it is owed $251,264 for royalty payments overpaid to the DNR. Kelly Farr, a spokesman for CMS Nomeco, said Terra "believes in paying what's right and we paid what's right." Mr. Farr added that the audits underlying Mr. Kelley's lawsuit have "a lot of mistakes."The central question in the dispute involves how the industry and the state define the price of natural gas.

Terra interprets its lease with the state to mean that the company should pay royalties and severance taxes on the "fair market value," which is equivalent to the monthly posted spot market price for natural gas in Michigan. During the period covered by the lawsuit, Terra reported it was receiving roughly $1.24 per thousand cubic feet for gas produced on state land.

The Attorney General asserts that companies leasing state minerals are obligated to pay on what "they actually receive for the gas." That is, calculations for royalties and severance taxes must be based on the value of the gas in the commercial market. The commercial market price varied, but from 1992 to 1995, according to the state, Terra received $3.15 per thousand cubic feet for a sizeable share of its production.

The state's $2.3 million lawsuit against Terra covers 214 of the 529 wells that the state says Terra owns and operates on state land. (Terra disputes the total, saying the number is closer to 400). Recognizing that it may be owed millions of dollars more, state auditors are preparing for an expanded audit, and studying production and royalty payment records to quantify how much Terra may owe from its other wells on state land.

"We understand the magnitude of the issue," said Anthony J. Herek, an audit manager in the DNR's Office of Internal Audit.

Mr. Herek said the DNR also may request clearance from the Treasury Department to review the tax records of Terra and some of the 30 other Antrim gas producers that operate on state land. In the 1997 fiscal year that ended in September, the state collected $40.96 million in energy severance taxes; $35.21 million of that was from natural gas production.

Lyle Mather, the Treasury Department's administrator of Motor Fuel, Tobacco and Severance Taxes, said that his division had undertaken spot audits of some energy producers. He declined to discuss specific companies, but said that in some cases "there are discrepancies," and that additional severance tax payments have been sought.

CONTACTS:Chris DeWitt, Attorney General's Office, 517-373-8060; Anthony Herek, Department of Natural Resources, Office of Internal Audit. Tel. 517-335-6814, fax 517-241-1370, hereka@state.mi.us; Kelly Farr, CMS Nomeco, 313-436-9253.