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Michigan's Oil and Gas Debate State Widens Investigation of Terra Energy Company May Have Pocketed Millions More in Public Royalties A widening investigation by the Attorney General and the Department of Natural Resources has producedstriking evidence that Antrim natural gas producers may have wrongfully withheld millions more dollars inroyalty payments than has yet been made public, according to interviews with state officials and recentlyreleased public documents. In addition, the Michigan Department of the Treasury is analyzing company records to determine whetherthey underpaid the state severance tax on natural gas production. The investigations represent the most intensive financial scrutiny the energy industry ever has beensubjected to in Michigan. Atarget of the state probe is Terra Energy, a Traverse-City based subsidiary of CMS Nomeco and thelargest producer of Antrim gas. In January Attorney General Frank Kelley filed a lawsuit against Terra torecover $1.4 million in royalty payments that the state asserts the company wrongfully withheld from January1992 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 donenothing wrong, and that it is owed $251,264 for royalty payments overpaid to the DNR. Kelly Farr, aspokesman for CMS Nomeco, said Terra "believes in paying what's right and we paid what's right." Mr. Farradded 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 onthe "fair market value," which is equivalent to the monthly posted spot market price for natural gas inMichigan. During the period covered by the lawsuit, Terra reported it was receiving roughly $1.24 perthousand cubic feet for gas produced on state land. The Attorney General asserts that companies leasing state minerals are obligated to pay on what "theyactually receive for the gas." That is, calculations for royalties and severance taxes must be based on the valueof the gas in the commercial market. The commercial market price varied, but from 1992 to 1995, accordingto the state, Terra received $3.15 per thousand cubic feet for a sizeable share of its production.

The state's $2.3 million lawsuit againstTerra covers 214 of the 529 wells that thestate says Terra owns and operates on stateland. (Terra disputes the total, saying thenumber is closer to 400). Recognizing that itmay be owed millions of dollars more, stateauditors are preparing for an expanded audit,and studying production and royalty paymentrecords to quantify how much Terra may owefrom its other wells on state land. "We understand the magnitude of the issue," said Anthony J. Herek, an auditmanager in the DNR's Office of InternalAudit. Mr. Herek said the DNR also may requestclearance from the Treasury Department toreview the tax records of Terra and some ofthe 30 other Antrim gas producers thatoperate on state land. In the 1997 fiscal yearthat ended in September, the state collected$40.96 million in energy severance taxes;$35.21 million of that was from natural gasproduction. Lyle Mather, the Treasury Department'sadministrator of Motor Fuel, Tobacco andSeverance Taxes, said that his division hadundertaken spot audits of some energyproducers. He declined to discuss specificcompanies, but said that in some cases "thereare discrepancies," and that additionalseverance tax payments have been sought. CONTACTS:Chris DeWitt, AttorneyGeneral's Office, 517-373-8060; AnthonyHerek, Department of Natural Resources,Office of Internal Audit. Tel. 517-335-6814,fax 517-241-1370, hereka@state.mi.us; KellyFarr, CMS Nomeco, 313-436-9253.

The Department of Natural Resources has completedseveral audits investigating Antrim gas developers for improperly withholding state royalties and for excessive operating cost deductions. These audits generally cover production from 1993 to 1995 ofselected wells on state lands:

Antrim Operator Amount Owed Audit Cost (Absorbed bythe State) Terra Energy $2,339,641 $107,743 Muskegon Development $317,266 $21,720 Shell Oil $155,173 $17,968 Ward Lake Drilling $147,291 Included with Muskegon audit CMS/Nomeco $4,739 $18,430 Wolverine Environmental Production $3,749 Included with Nomeco audit Oilfield Energy Not yet public $37,952 Trendwell Energy Not yet public $28,182 Total $2,967,859 $231,995

The DNR now is auditing Antrim Gas, Inc., and ispreparing to audit Antrim Development, HRF Exploration and Mercury Exploration. The agency also is expanding the Terra audit to include all wells the company operates on state lands, from 1992 tothe present. Source: Department of Natural Resources