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For nearly 25 years, property owned by oil and gas companies in California has not been assessed for taxes unless there were proven reserves beneath the ground. But that might be changing. In a move that shocked petroleum industry executives, the California Supreme Court last week let stand a lower court ruling that went against time-honored tradition by allowing assessors to tax land containing so-called “unproved reserves” at its fair-market value. Petroleum industry experts say the decision by Fresno’s Fifth District Court of Appeal “radically transforms” the way the state’s energy reserves are assessed and could affect billions of dollars in oil and gas rights. “The court of appeal ignores the essential requirement that assessable oil and gas property interests in California be based, first and foremost, on the existence of reserves as demonstrated by geological and engineering information,” Gregory McClintock, a Los Angeles attorney for three petroleum companies, wrote in an amicus curiae letter filed with the Supreme Court. “The court’s decision removes this prerequisite entirely . . .and inserts in its place a measure based upon speculative unproved reserves.” Monterey lawyer Sean Flavin, an expert on property taxation who also sided with the oil companies in a separate amicus letter, predicted late last week that the ruling will have significant impact. “The question will be, what will be the ramifications of this for the industry generally?” he said. “Will this result in there being increased assessments of oil reserves that are unproven? That’s the question that is going to be troublesome for the industry as a whole.” The case was touched off when Kern County Assessor James Maples assessed Occidental of Elk Hills Inc. $3.65 billion for 37,000 acres the oil company had bought from the federal government in 1998. Maples assessed the land at its fair-market value on the reasoning that the state’s Revenue and Taxation Code creates a rebuttable presumption that a site’s purchase price is equal to its taxable value. Oil company lawyers argued, however, that the assessor was bound by State Board of Equalization Rule 468, which since 1979 — in response to Proposition 13, the 1978 ballot measure that rolled back real property assessment values to 1975 standards and limited yearly increases — had restricted assessment to land with “proved reserves.” Those, they argued, were defined as oil and gas reserves “which geological and engineering information indicate with reasonable certainty to be recoverable in the future.” Oil and gas executives also pointed to Lynch v. State Board of Equalization, 164 Cal.App.3d 94, a 1985 ruling by Sacramento’s Third District, which held that there must be a reasonable certainty that oil and gas reserves exist before they can be proved and, thus, assessable. Lynch has long been considered the seminal decision on the issue. The oil companies were even backed by Ernest Dronenburg Jr., a partner in Deloitte & Touche’s San Diego office and a former member of the State Board of Equalization who helped write Rule 468. “In order to avoid placing speculative values for oil and gas reserves that might not even exist on the property tax roles,” he wrote in an amicus letter filed with the high court, “the BOE deliberately did not make unproved reserves a part of the assessable property right under Rule 468.” Occidental won at the local level, when the Kern County Assessment Appeals Board reduced its $3.65 billion tax bill to $1.92 billion. But on Oct. 29, Fresno’s Fifth District, in a ruling authored by Justice Steven Vartabedian, reversed while calling the Lynch court’s discussion of proved reserves dicta. “We conclude that Rule 468 does not attempt to create an exception to the fair-market value basis of taxation,” Vartabedian wrote. “Rather � the rule crystallizes the fair-market value standard in the particular context of the right to extract petroleum from the ground.” The decision enraged and frightened oil and gas executives. “The court literally rewrote the book on property taxation in a highly complex and technical field governing a significant amount of taxable property in California,” Occidental’s lawyer, Theodore “Ted” Boutrous Jr., wrote in the company’s unsuccessful Supreme Court review petition. Boutrous, a partner at Los Angeles’ Gibson, Dunn & Crutcher, could not be reached for comment, but in his court papers he predicted there would be “wildly disparate and unequal tax treatment” for oil and gas companies around the state if the Fifth District ruling stood. “In those counties where assessors decide to follow the Fifth District’s new interpretation,” he wrote, “not only will the assessment method employed be substantially different than that in counties that follow Lynch, but the result will be speculative assessments, severe practical problems and uncertainty, compounded by both under- taxation and double taxation.” Boutrous’ opponents in the Kern County counsel’s office say oil executives are exaggerating the impact of the ruling, which, they say does not conflict with Lynch. That decision upheld the constitutionality of Rule 468, they argue, but did not address the definition of proved reserves. They also predict no industry-wide disaster because Occidental’s lump-sum acquisition of its fee-simple interest in its property differed from other companies, whose oil and gas interests are created by lease and the purchase price is not a definite sum. “Hence, none of the issues presented by this case will arise in the ‘vast majority’ of oil and gas transactions,” they wrote. “The decision in this case arises out of a rare � if not unique � set of facts that has never arisen before in the 23 years since Rule 468 was adopted.” County Counsel Bernard Barmann Sr. conceded late last week that the ruling comes in “one of the biggest oil cases in recent years.” But he believes oil executives will cope. “The oil companies historically have had a problem with paying taxes on a non-producing field, and that’s understandable,” he said. “Under this [ruling], it’s black gold in the ground, and whatever they pay for it goes on the roll as a base-year value.” The Fifth District ruling is Maples v. Kern County Assessment Appeals Board, 103 Cal.App.4th 172.

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