Millions at stake in Kinder Morgan tax dispute

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Montezuma County’s biggest taxpayer may owe millions more in taxes, depending on the outcome of a dispute between carbon- dioxide producer Kinder Morgan CO2 Co., LP, and the assessor’s office.

On Dec. 19, the county commissioners tabled a decision on a tax-abatement plea from Kinder Morgan in order to see whether company officials and Assessor Mark Vanderpool could come to a compromise agreement on how much the company should pay.

The hearing – which featured brain-straining details of assessment methodology – was over six Kinder Morgan accounts for the 2008 tax year, based on production in 2007. The results could have ramifications for the taxes Kinder Morgan will pay in future years.

Vanderpool told the commissioners that his office initiated a production audit for the company in May 2008. Taxpayers have two years to file for an abatement, and Kinder Morgan used most of that time, accounting for the delay in the hearing, Vanderpool said.

The audit – which included visits to Kinder Morgan’s Houston offices and the services of an energy-tax expert hired by the county – resulted in an increase in the company’s assessed value of more than $50 million.

That translated into an increase in property tax of approximately $2.03 million, Vanderpool said.

It also resulted in a decrease in Kinder Morgan’s state severance tax of approximately $1.76 million, because oil and gas producers in Colorado may deduct 87 percent of the local property taxes they pay from their state severance tax.

Vanderpool said he decided to audit the company for several reasons, but primarily because it accounts for over 95 percent of oil and gas production in Montezuma County. Oil and gas companies self-report their production values and it is difficult for him and his staff to quantify the value of CO2 in order to verify those numbers, he said.

The company’s reported production value in 2008 dropped from the prior year “and I didn’t understand that,” he said.

“Certainly it was not an effort to hurt any single taxpayer,” Vanderpool said.

“I didn’t know whether this would raise one nickel more in tax, but I just wanted to have a feeling of comfort that it was right.”

Company officials were helpful and courteous during the audit, he emphasized. “They bent over backwards cooperating with us in this process.”

Close ties

At the hearing, both Vanderpool and Walker Knight, director of property taxation for Kinder Morgan from Houston, acknowledged the close relationship between the company and the county.

Kinder Morgan is critical to county revenues, as the company pays close to 40 percent of the county’s property taxes. On the other hand, the McElmo Dome formation in Montezuma and Dolores counties is one of the largest CO2-bearing formations in the country, containing some 10 trillion cubic feet of CO2, so Kinder Morgan is not likely to shift its production elsewhere.

“Primarily owned by Kinder Morgan CO2 (the operator) and ExxonMobil, the McElmo Dome is one of the world’s largest known accumulations of nearly pure CO2,” states Kinder Morgan’s web site. “This dome produces from the Leadville formation at 8,000 ft. with 61 wells that produce at individual rates up to 50 MMCFD [millions of cubic feet per day].”

Most of that CO2 is piped to west Texas to be injected into oil wells to force more oil out of the ground.

“We are very appreciative of the opportunity to operate here and I think we have been good for the community, and certainly the community has been good for us,” Knight told the board.

‘Related parties’

The crux of the tax dispute is the size of the deduction Kinder Morgan can subtract from its revenues for the cost of transporting the CO2 to Texas.

Under state law, companies are allowed to deduct the price of the tariff they pay to a pipeline company to move the gas – so long as that pipeline company is not a “related party” to the producer.

If the pipeline company is a “related party,” the energy producer can only deduct for actual transportation costs, a lesser amount than the tariff.

The 502-mile, 30-inch pipeline used by the company, known as the Cortez Pipeline, is owned in large part by Kinder Morgan. The company operates the pipeline as well, Knight said.

The pipeline originates in Montezuma County and heads southeast to oilfields in Yoacum County, Texas.

Knight told the board his company owns a 50 percent share of the Cortez Pipeline. Kinder Morgan’s partner, ExxonMobil, owns 37 percent, and 13 percent is owned by an unrelated third-party investor, Cortez Vickers Pipeline Co., based in New York, he said.

But Knight said the pipeline is not a “related party” because the tariff must be approved by all the owners and is charged to all parties who transport CO2 through the pipeline, not just Kinder Morgan.

“Kinder Morgan and Cortez Pipeline are not related entities,” Knight said, because “a significant though minority share is owned by a third-party investor who has veto power” over the price of the tariff.

However, a 2009 quarterly report from Kinder Morgan Energy Partners, LP, on the company’s web site makes reference to “our indirect ownership of Cortez Pipeline Company through Kinder Morgan CO2 Company, L.P.”

Knight said Kinder Morgan had always used the tariff as its transportation deduction.

“We used the Cortez Pipeline tariff as the cost of transporting the product,” Knight told the board.

“We followed the same methodology we had used all along before 2008, and I think Shell [the previous CO2 operator in Montezuma County] did it that way too.”

Knight said the difference between the tariff and the actual cost would be 21 cents vs. 9 cents per unit.

Paying themselves?

But Vanderpool said his office had followed state law and the Assessor’s Reference Library guidelines “every step of the way.”

He cited the definition of “related parties” in the ARL: “individuals who are connected by blood or marriage; or partnerships; or businesses that are subsidiaries of the same parent company or are associated by one company controlling or holding ownership of the other companies’ stock or debt.”

“We believe the tariff is not an actual expense because they are actually paying themselves,” Vanderpool said. “Eighty-seven percent of that tariff is being paid to the people who own the product.

“We feel pretty adamantly that they are related.”

Tax consultant Mary Ellen Denomy, a certified public accountant specializing in mineral rights who has testified before the state oil and gas commission and the state legislature, supported Vanderpool.

“There is a two-step issue that we looked at,” she told the board. “First, is Kinder Morgan a related party, and are they connected by a partnership or a business ownership? We determined it was yes.

“Then there is a set of statutes that dictate through the ARL as to how they’re treated. It’s either, do you take the tariff or do you take the actual expenses? So we said, you take the actual expenses.” Those actual expenses were determined to be $48.3 million.

“We believe the actual expenses are the only legitimate expenses,” Vanderpool said.

Commission attorney Bob Slough cited language in state statutes about the expense “borne by” the taxpayer and said if half of the supposed cost of production comes back to the company as revenue, it isn’t actually being borne by that company.

“What expenses are actually borne by the taxpayer? From my standpoint that would be the focal point of this issue,” Slough said.

Charging yourself rent

Kinder Morgan paid the increased 2008 tax under protest.

Since then, Kinder Morgan has continued to report its revenues based on the tariff, Vanderpool said, and he hasn’t challenged that because he is waiting to see what happens with the 2008 case. In the next three years, the tariff dropped, so the tax difference would not be so large for those subsequent years.

Meanwhile, company officials had discussions with Vanderpool about a compromise but were unable to come to an agreement. Vanderpool said the only reason he was willing to settle was to avoid a drawn-out court battle, not because he didn’t think he was right.

At the hearing, Commissioner Steve Chappell asked several questions to clarify that half of what is collected by Cortez Pipeline goes back to Kinder Morgan.

“It’s like charging yourself rent for living in your own house,” Chappell said.

And Commissioner Gerald Koppenhafer told Knight, “You could charge so much for the thing [tariff] that you could take all the profit out of it and you’re just paying yourself back.”

But Knight repeated that the non-operator owner, Cortez Vickers, has veto power over the price of the tariff, and added that anyone using the pipeline is charged the same fee.

“It’s not like we get special treatment.”

He said there are other shippers such as Occidental who use the pipeline who are not related to Kinder Morgan.

But Vanderpool said of all the product that went through the Cortez Pipeline in 2007, 93 percent was for Kinder Morgan and Exxon- Mobil CO2, and just 7 percent for other operators. “The law of supply and demand tells me that if I’m going to transport 93 percent of a product through a pipeline, I’m going to strike a better bargain with that pipeline than a guy who’s going to transport 7 percent.”

Koppenhafer expressed concern that no one from ExxonMobil was there to represent the company, but Vanderpool said it didn’t really matter, because Kinder Morgan is the actual taxpayer and goes to the partners to get their share of the bill.

25 percent off

“The assessor’s not here to try to rape Kinder Morgan or hurt them,” Vanderpool said. “The assessor is trying to make sure they pay their fair share.

“My heart goes out to the senior citizen who sits across my desk crying because she can’t pay for her food and her taxes and her medicine more than my heart goes out to Kinder Morgan.”

Knight said he would like more time to talk with his superiors and with Vanderpool.

“I don’t know that anybody in the world is going to be persuasive enough to make me sharpen my pencil and make a better offer than I already have,” Vanderpool said.

He said he had offered to take 25 percent off the 2008 value, and the tax, with the condition that Kinder Morgan would not protest and that the assessor would not reevaluate taxes for years prior to 2008.

Kinder Morgan’s taxes for 2009, 2010 and 2011 would be reassessed using the actual production costs, and 25 percent would then be taken off those taxes as well, he said.

“Whatever we decide is going to tax this entity down the road forever,” Chappell said. “And they can appeal forever, and probably will,” Vanderpool said

The hearing was continued until Feb. 6 at 11 a.m.

As of Dec. 29, Vanderpool said he had not heard back from Kinder Morgan regarding any settlement.

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