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You can search the entire site. or go to the recent opinions, or the chronological or subject indices. ConocoPhillips Alaska, Inc. v. State, Dept. of Natural Resources (01/28/2005) sp-5864

ConocoPhillips Alaska, Inc. v. State, Dept. of Natural Resources (01/28/2005) sp-5864

     Notice:   This opinion is subject to correction  before
     publication  in  the  Pacific  Reporter.   Readers  are
     requested to bring errors to the attention of the Clerk
     of  the  Appellate  Courts, 303  K  Street,  Anchorage,
     Alaska 99501, phone (907) 264-0608, fax (907) 264-0878,
     e-mail corrections@appellate.courts.state.ak.us.


            THE SUPREME COURT OF THE STATE OF ALASKA

CONOCOPHILLIPS ALASKA, INC.,  )
EXXON MOBIL CORPORATION, )    Supreme Court No. S-11131
EXXONMOBIL ALASKA        )
PRODUCTION INC., and FOREST   )    Superior Court No.
OIL CORPORATION,              )    3AN-01-10283 CI
                              )
               Appellants,         )
                              )
          v.                  )    O P I N I O N
                              )
STATE OF ALASKA,              )
DEPARTMENT OF NATURAL    )    [No. 5864 - January 28, 2005]
RESOURCES,                    )
                              )
               Appellee.      )
                                                                )

          Appeal  from the Superior Court of the  State
          of    Alaska,   Third   Judicial    District,
          Anchorage, Donald D. Hopwood, Judge.

          Appearances: Joseph J. Perkins, Jr., Guess  &
          Rudd,   P.C.,   Anchorage,  for   Appellants.
          Leonard   H.   Herzog,   Assistant   Attorney
          General,  Anchorage,  and  Gregg  D.  Renkes,
          Attorney General, Juneau, for Appellee.

          Before:   Bryner,  Chief  Justice,  Matthews,
          Eastaugh, Fabe, and Carpeneti, Justices.

          BRYNER, Chief Justice.


I.   INTRODUCTION

          ConocoPhillips  Alaska, Inc., Exxon Mobil  Corporation,

ExxonMobil  Alaska  Production Inc., and Forest  Oil  Corporation

(the  corporations) applied to reduce the rate of lease royalties

they  owed  the  State  of Alaska under a state  lease  initially

executed  in  1965.  They claimed that they were  entitled  to  a

discovery  royalty rate because they were the first producers  to

discover  oil  in  a  new geologic structure,  the  Midnight  Sun

Reservoir.   The  Commissioner of Natural  Resources  denied  the

application, finding that the Midnight Sun Reservoir belonged  to

a  known  geologic structure, the Kuparuk C sandstone  formation.

We   affirm  the  commissioners  decision,  holding  that  it  is

supported  by  substantial evidence and correctly  construes  the

terms  of the lease according to the law in effect when the lease

was  signed.    We  also  hold that the  commissioner  improperly

barred  the  corporations  counsel  from  participating  in   the

administrative  hearing,  but we conclude  that  this  error  was

harmless because the corporations have failed to show substantial

prejudice.

II.  FACTS AND PROCEEDINGS

     A.   Background

          1.   The discovery royalty program

          In  1959 the legislature enacted the Alaska Land  Act.1

A  provision  of  the  Act formerly codified as  AS  38.05.180(a)

established a reduced royalty rate for state leaseholders  making

the first commercial discovery of oil in a geologic structure:

          the  holder  of a lease who shall  drill  and
          make  the  first discovery of oil or  gas  in
          commercial   quantities   in   any   geologic
          structure   shall  pay  a  royalty   on   all
          production  under the lease of 5  per  centum
          for  ten  years following the  date  of  such
          discovery  and  thereafter the  royalty  rate
          shall be not less than 12 per centum.[2]
          
This  discovery  royalty  encouraged the  exploration  and  rapid

development of Alaskas oil resources.  Between 1959 and 1964, the

Department  of Natural Resources adopted regulations implementing

the  discovery royalty statute.3  Among these regulations was the

DL-1  competitive  oil  and  gas lease  form.4   The  DL-1  lease

included  a  discovery  royalty clause nearly  identical  to  the

provisions  of  subsection .180(a), and also  provided  that  its

terms  would be interpreted according to regulations in force  at

the time the lease was entered.5

          The  regulations established a process allowing lessees

to  apply for discovery royalties and set the guidelines for  the

department to determine whether an award was warranted.6  The new

regulations  required applicants to provide the  department  with

data  to  determine  the geologic structure from  which  the  oil

and/or  gas  is being produced7  a requirement echoing subsection

.180(a)s  language authorizing the department to award  discovery

royalties only for the first discovery of oil . . . in a geologic

structure . . . .8

          As   then   defined  in  11  AAC  505.741(b),  geologic

structure  meant  any structural and/or stratigraphic  entrapping

mechanism  containing  one  or  more  intervals,  zones,  strata,

formations,  or  fault  blocks which has the  necessary  physical

characteristics  to  accumulate and prevent  the  escape  of  oil

and/or  gas.  The regulation further stated: It is intended  that

the meaning shall be similar to that as used by the United States

Geological  Survey in the administration of the  Federal  Mineral

Leasing Act of February 25, 1920.9

          The  Federal  Mineral Leasing Act10 uses  the  geologic

structure  concept to differentiate types of oil and  gas  leases

before   leasing  occurs.   If  the  Secretary  of  the  Interior

determines that government lands are not within a known  geologic

structure  of a producing oil or gas field11 they may  be  leased

without  competitive bidding.12  As of 1959,  the  United  States

Geological  Survey  (USGS) defined the Acts term  known  geologic

structure  as  the trap, whether structural or stratigraphic,  in

which  an accumulation of oil or gas has taken place.  The limits

of  such  structure  include all acreage  that  is  presumptively

productive.13

          In  1967 and 1969 the Alaska legislature curtailed  and

then repealed the Alaska Land Acts discovery royalty provisions.14

The  departments  regulations implementing the discovery  royalty

program were repealed in 1979.

          2.   History of the lease before the discovery well

          The corporations predecessors-in-interest purchased ADL

28299, a DL-1 form lease, in 1965.  Like others of its kind,  the

lease   includes  a  discovery  royalty  clause  that  is  nearly

identical to former AS 38.05.180(a) (1965).15  Moreover, according

to  paragraph 43 of the lease, As used in this lease words  which

are  defined in the regulations have the meaning assigned by such

definition except where the context clearly requires a  different

meaning.    And  paragraph  42  provides  that  in   this   lease

regulations  mean the applicable and valid oil  and  gas  leasing

regulations  of  the  Commissioner of the Department  of  Natural

Resources  in  effect on the effective date of this lease  unless

otherwise specified.

          The  corporations  lease  contains  approximately  four

square miles, divided into four sections.  The North Prudhoe  Bay

bounding  fault transects the leased land.  Three  of  the  lease

sections,  those  south  of the fault, overlay  the  Prudhoe  Bay

reservoir. The northeast section, section 30, lies north  of  the

fault  and  outside  the  Prudhoe Bay  reservoir.   In  1977  the

sections  south  of the fault were committed to the  Prudhoe  Bay

Unit Agreement.16

          While  oil  development was concentrated south  of  the

fault  in the Prudhoe Bay reservoir  the largest accumulation  of

oil  in North America  discoveries at Niakuk and Pt. McIntyre  in

1985  and 1988 proved that the Kuparuk C sandstone north  of  the

fault  was also a source of commercial quantities of oil.   These

discoveries were not within section 30 of the lease.  The Kuparuk

sands  do  not  form a continuous layer north of the  fault,  but

rather  a  series  of  depositions  in  noncontiguous  geographic

depressions.

          In  1997  the  corporations drilled the Sambuca  No.  1

well, which aimed at land north of the fault in section 30.   The

target  of  Sambuca  1  was  Ivishak  sandstone,  but  it  tapped

quantities  of  oil  in  an intervening layer,  a  geographically

discrete   bed  of  oil-bearing  Kuparuk  C,  the  Midnight   Sun

Reservoir.

     B.   Proceedings

          Based   on  this  find,  the  corporations  began   the

application  process for a discovery royalty,  applying  formally

for certification of the Midnight Sun Reservoir discovery royalty

in 1999.  The Department of Natural Resources Director denied the

application,  finding  that  the  Reservoir  was  not   a   newly

discovered  geologic  structure  as  defined  by  former  11  AAC

505.741(b) (1965).

          The corporations appealed the directors decision to the

commissioner  under  11  AAC 02.030.17  In  accord  with  11  AAC

02.030(b),  they  submitted additional materials  in  support  of

their appeal, including: a fifty-six-page legal brief, a fifteen-

page  expert  report, a list of discovery royalty statistics,  an

affidavit,  and  research  supporting an  old  discovery  royalty

application.

          Under  11 AAC 02.050(b) (2004),18 the commissioner  set

the  following hearing procedure: the Division of Oil and Gas was

allowed  two and one-half hours to explain the directors decision

denying   the   application;  then  the  corporations   technical

personnel  were allowed thirty minutes to question the  divisions

technical   personnel;   followed  by   a   two-and-one-half-hour

presentation   by   the  corporations  and  thirty   minutes   of

questioning   by   the   divisions  technical   personnel.    The

commissioner described his goal as to allow [the corporations] to

present  all relevant facts about North Slope geology that  could

assist  me in determining whether the Sambuca No. 1 well was  the

first  discovery  of  oil or gas in commercial  quantities  in  a

geologic structure.

          The  corporations objected to the commissioners  choice

of  procedures  by  letter.   They asked  that  the  commissioner

reconsider his  requirements that no attorney be allowed to  make

a  presentation  or  to  question any of the  persons  presenting

information during the hearing and that questions not be posed in

the  form  of  cross-examination.   The commissioner declined  to

alter the hearings procedural rules, stating, [t]he facts will be

most helpful to me if presented by the geologists, engineers, and

other  persons with technical expertise bearing on  these  facts,

rather than by attorneys.

          Following  the  hearing,  the  commissioner  issued   a

written decision affirming the directors ruling.  Initially,  the

commissioners  decision  found  that  whether  the  Midnight  Sun

Reservoir   was  a  previously  undiscovered  geologic  structure

depended   on   former  11  AAC  505.741(b)s   definition.    The

commissioner discussed the USGSs 1959 definition of  the  federal

Acts  reference to a known geologic structure  which  focused  on

the  presence of a trap . . . in which an accumulation of oil  or

gas has taken place19  but found it unhelpful.  Noting that

          [e]xperts   could  validly  differ   on   the
          boundaries  of a [known geologic  structure],
          depending  on  their  view  of  geology   and
          terminology. . . . [T]he regulatory reference
          to   the  old  federal  laws  is  of  limited
          assistance  in finding the precise definition
          of  geologic  structure that was intended  by
          the Alaska statute and regulations.
          
The  commissioner thus opted for a more recent approach  emerging

from  the  departments own royalty decisions.   Relying  on  this

precedent, the commissioner found that the Midnight Sun Reservoir

was not a newly discovered geologic structure, in part because it

shared   an  entrapping  mechanism  with  other  discoveries   of

commercial oil in the Kuparuk C formation.

          The   commissioner  explained  that  the  Midnight  Sun

Reservoir  exhibited  the  same  entrapping  mechanism   as   the

previously  discovered Kuparuk formation, in part,  because  they

shared  the same stratigraphic elements:  [They] are all overlain

          by Gamma Ray Shale[,] . . . [which] acts as a seal and is part of

the  stratigraphic trap that makes the Kuparuk sands a reservoir.

Also, the Midnight Sun shared structural characteristics with the

previously discovered Kuparuk sands, since the controlling faults

fit  a pattern, and all of the Kuparuk accumulations are part  of

an  apparent trend north of the Prudhoe Bay bounding fault.   The

commissioner noted that this finding was consistent with much  of

the  evidence  presented  by  the  corporations,  and  while  the

corporations  expert  arrived  at a different  conclusion,  [his]

argument . . . is one of several working hypotheses regarding the

timing  of  depositional  topography, erosional  truncation,  and

faulting in the area, and is not determinative of whether the two

are on different geologic structures.

          The  commissioner  went on to reject  the  corporations

contention   that  the  Midnight  Sun  Reservoir    automatically

qualified  for a discovery royalty because it was  separate.   He

reasoned  that although the Midnight Sun is a separate reservoir,

it   is  not  trapped  by  a  geologically  different  entrapping

mechanism.   In  the commissioners view, the corporations  narrow

approach would prove unworkable:

               The  broader interpretation of the  term
          geologic  structure that is adopted  here  is
          the  most  sensible  because  it  avoids  the
          unreasonable outcomes that could result  from
          Lessees  interpretation, outcomes  that  were
          not intended by the Legislature.  That is, it
          could   be   that  innumerable  pockets,   or
          accumulations,   are  isolated   from   other
          reservoirs on the North Slope; each cannot be
          considered a separate geologic structure,  or
          scores  of small pockets of oil would qualify
          under the program.  That was not the programs
          intent,  and interpreting the term  that  way
          now  would simply lead to incongruities, both
          from the regulatory and fiscal standpoint  of
          the state.
          
          Applying  the  broader approach  he  gleaned  from  the

departments prior decisions, the commissioner described the scale

of  this [geologic] structure as the Kuparuk C sands north of the

Prudhoe  Bay bounding fault . . . [including] Kuparuk C sands  at

West   Beach,  Niakuk,  Pt.  McIntyre  and  Gwydyr  Bay.    While

recognizing that this broader approach might lead the  department

to  reach different results now than it reached in the past,  the

commissioner justified the differing outcomes by emphasizing that

[o]ur   increased  knowledge  and  ability  to  incorporate   new

information has led us to a more sensible view of the geology and

of  the  role that the discovery royalty program should  play  in

North Slope exploration.  The commissioner pointed to advances in

data   collection   (e.g.,  3-D  seismic  technology),   to   the

establishment  of  industry infrastructure  that  makes  drilling

wells  easier, and to the general development of the North  Slope

as  a  mature  oil  province in the years since the  program  was

established.

          The commissioner also found that drilling the Sambuca 1

did  not  present the same commercial risk as earlier discoveries

in  the  Kuparuk.   Pointing  to the  risks  that  the  companies

undertook and how that risk might further the policies behind the

discovery royalty program, the commissioner explained that, since

the program was created when Alaska was young as an incentive  to

encourage  companies  to explore for and develop  our  resources,

this  decision must consider whether those inducements  would  be

promoted  by  granting the application.  The  commissioner  noted

that the Sambuca 1 well had been drilled from an existing pad  in

a well-developed and densely-drilled area of the North Slope on a

lease  that  had  been included in the Prudhoe Bay  Unit  for  20

years.   While acknowledging that the Kuparuk sands were not  the

wells primary target, he stressed that seismic information showed

the  Lessees that something else was present  they tailored their

directional drilling plan to evaluate the anomaly on the  way  to

the   wells  primary  Ivishak  objective.   Because  Ivishak  was

relatively   low  risk,  the  commissioner  reasoned   that   the

corporations decision to drill had not actually been motivated by

the  possibility of obtaining a discovery royalty.   Given  these

circumstances, the commissioner concluded:

          [I]t  would be neither wise nor fair, nor  in
          keeping  with  the Departments  policies,  to
          reward   drilling  a  well  for   which   the
          potentially lower royalty rate was apparently
          not  considered,  and which would  have  been
          drilled regardless of this accumulation.  The
          discovery  royalty  was  intended  to  reward
          companies for taking risks, not for a routine
          evaluation of additional formations en  route
          to   a  formation  known  to  be  productive.
          Because  the  discovery royalty  provided  no
          incentive to the drilling of the Sambuca  No.
          1  well,  the Lessees should not be  rewarded
          with an incentive payment.
          
          The corporations appealed the commissioners decision to

the  superior  court and requested a trial de novo, arguing  that

the  departments  appellate procedures were unconstitutional  and

inadequate  for  resolving  a  contract  dispute  in  which   the

department was an interested party.  Superior Court Judge  Donald

Hopwood declined to conduct a de novo hearing, finding no showing

that  the  department had been biased or that evidence  had  been

improperly excluded.  The superior court thus treated the case as

an  ordinary  administrative appeal, reviewing the  commissioners

decision deferentially.

          The  superior  court later issued a decision  affirming

the commissioners ruling.  The corporations appeal.

III. DISCUSSION

     A.   Standard of Review

          When  the superior court acts as an intermediate  court

of  appeal  in an administrative matter, we directly  review  the

merits  of the agencys decision.20  We apply a four-part standard

to  review  the  merits  of the agencys  ruling,  using  (1)  the

substantial  evidence  test  for  questions  of  fact,  (2)   the

reasonable  basis  test  for questions of  law  involving  agency

expertise, (3) the substitution of judgment test for questions of

law involving no agency expertise, and (4) the reasonable and not

arbitrary test for review of administrative regulations.21

          Here, the corporations devote a considerable portion of

their arguments to protesting the superior courts reliance  on  a

          deferential  standard of review.  They argue  that  the

commissioners  decision should be reviewed de novo because  their

royalty rights arise under their lease, not under the departments

regulations.  Since the terms of the lease became fixed  when  it

was  originally  signed,  the  corporations  insist,  the  leases

original  meaning  must  now  be determined  and  enforced  under

conventional principles of contract interpretation,  which  treat

the issue as a pure question of law.

          This  argument seems unobjectionable as far as it goes,

but  it  stops short of completely covering the matter at  issue.

The corporations are certainly correct in describing the lease as

a  contract,  in  insisting that its terms must  be  given  their

original    meaning,   and   in   observing   that    contractual

interpretation generally presents a question of law.   Yet  these

observations  beg the key question of what measure  the  original

lease  adopts  for determining the existence of  first  discovery

rights.

          As  already mentioned, the lease unambiguously requires

the   lessees  royalty  rights  to  be  determined   through   an

administrative  process  in which the  department  must  apply  a

specified  regulatory standard  one that gives the term  geologic

structure a meaning similar to that as used by the United  States

Geological  Survey in the administration of the  Federal  Mineral

Leasing Act of February 25, 1920.22  The crucial question,  then,

is  whether this standard describes a fixed and immutable test or

a more flexible process  one grounded in the departments exercise

of  discretion and expertise and having the capacity to evolve as

contemporary  scientific knowledge advances.   If  the  test  was

fixed  and certain when the lease was signed, then Midnight  Suns

status  as a new discovery might well present a pure question  of

law  to  be  decided  de novo; conversely, if applying  the  test

required agency expertise and discretion, then judicial review of

the   commissioners  ruling  would  need  to   be   appropriately

deferential.        The corporations separately argue  that  they

          deserved a de novo hearing because the department had a

proprietary interest that prevented it from acting without  bias,

because  the  commissioners hearing was procedurally flawed,  and

because  his  decision  conflicted  with  the  departments  prior

rulings.   These points involve issues of procedural due  process

raising questions of law that we review de novo.

          Last, in some of their arguments, the corporations  ask

us  to  review  the  commissioners  factual  findings  and  legal

conclusions.  Where the question involves more than the choice of

law,  we  will review these aspects of the commissioners decision

under  the reasonable basis test.23  This accords with  both  our

usual  deference to agency decisions and with the  terms  of  the

lease that make the award of a discovery royalty contingent  upon

an agency decision.24

     B.   The Commissioners Decision

          We  begin our review of the commissioners decision that

the  Midnight  Sun Reservoir was not a newly discovered  geologic

structure  by  examining the terms of the  lease  and  applicable

regulations.   Paragraph 12 of the lease states that  the  lessee

will  be entitled to a reduction in royalties owed the state upon

making the first discovery of oil or gas in commercial quantities

in  any  geologic structure.  Paragraphs 42 and 43 make it  clear

that  the  terms  of  the lease should be  defined  according  to

applicable  regulations in effect on the effective date  of  this

lease.

          The  corporations argue that the commissioners decision

is  contrary  to  Alaska  statutes,  the  lease  provisions,  and

applicable  regulations.   According  to  the  corporations,  the

decision  failed  to  apply  the federal known-geologic-structure

test,  and  instead proceeded in an ad hoc manner to  create  and

apply  several  new tests for awarding discovery  royalties  that

were more in keeping with his views of what current agency policy

should be.25  But the Alaska regulations in place when the  lease

was signed made it clear that the department was not confined  to

          a mechanical application of the known-geologic-structure test.

The  then-current version of 11 AAC 505.741(b) set out a detailed

definition  of geologic structure and stated that this definition

was  intended to be similar to the one used in the administration

of  the  Federal Mineral Leasing Act.26  The regulation qualifies

its  reliance on the federal standard.  The Alaska definition  of

geologic   structure  need  only  be  similar  to   the   federal

definition.   And the regulations express directive that  Alaskas

use  of geologic structure was intended to have a similar meaning

to  the  one  used in the administration of the federal  standard

rather  than  to  the federal standard itself  strongly  suggests

that  the  department viewed the federal standard as  an  ongoing

administrative   process  that  was  broad  enough   for   agency

discretion and flexible enough to evolve over time.

          Further evidence supporting this flexible view  of  the

Alaska  regulation defining geologic structure can be gleaned  by

comparing its purpose to the one served by the Federal Mining and

Land  Acts known-geologic-structure requirement.  Alaskas  system

of  discovery royalties was designed to allow royalty  reductions

to  be  granted case by case in future administrative proceedings

commenced  after  commercial  quantities  of  oil  and  gas  were

actually  found  on  lands  already  under  state  lease.27    As

exemplified  by this case, these proceedings might occur  decades

after  a  lease  was  signed and would almost  certainly  require

evaluation  of  detailed information that  would  not  have  been

known,  or even knowable, at the time of signing.  In the context

of   this  forward-looking  regulatory  process,  it  would  seem

unrealistic  for  the parties signing the lease  to  expect  that

geologic  structure would be defined in a static way  that  could

not adapt to changes in best available techniques and technology.

By  contrast,  as  used in the federal act,  the  known  geologic

structure  test  is designed for an immediate determination   one

that  classifies prospective lease lands before they are  put  up

for lease.  Given the federal acts narrower, present-tense focus,

          it would seem reasonable to expect that the federal system would

use a more concrete test: a test that would be practical to apply

based  on already available facts and would not need to adapt  to

future events.

          But  as the state correctly points out, even given  the

federal systems diminished need for flexibility, the federal test

has  never  actually been set in stone. Under the  federal  test,

areas  within a known geologic structure are subject to expansion

and consolidation with advances in geologic knowledge.28  In fact,

even the publication that the corporations rely upon acknowledges

that  known-geologic-structure boundaries are not to be taken  as

absolutely and accurately showing the extent in each instance  of

the geological structure producing oil or gas, but they may later

be  extended  or  reduced to accord with the facts.29   Moreover,

decisions of the Department of the Interior Board of Land Appeals

construing  the federal definition of a known geologic  structure

recognize  that a geologic structure may be composed of  multiple

accumulations  that are physically separate yet share  structural

characteristics, such as entrapping mechanisms:  Delineation of a

[known  geologic  structure]  recognizes  the  existence   of   a

continuous entrapping structure, on some part of which  there  is

production, or of numerous related, but nevertheless independent,

stratigraphic or structural traps.30  And pre-drilling  risk  may

also   be  a  consideration  under  the  federal  known-geologic-

structure analysis.31

          Despite the corporations contrary assertions, then, the

commissioners  method of determining geologic  structure  in  the

present  case  was similar to the federal test.  The commissioner

looked at three basic factors: whether the Midnight Sun Reservoir

was  a physically separate accumulation of oil; whether it had  a

structurally  distinct  entrapping  mechanism;  and  whether  its

discovery  entailed  commercial risk.  The commissioners  finding

that  the  Midnight Sun Reservoir belonged to the  already  known

Kuparuk  C  geologic  structure  thus  is  consistent  with   the

          federally defined standard.

          The corporations nevertheless dispute the commissioners

finding  that   the Kuparuk C sands comprised a  single  geologic

structure; they claim that this finding conflicts with the  plain

language   of   former  11  AAC  505.741(b)  by  indiscriminately

combining  oil traps and non-trapping rocks.  But former  11  AAC

505.741(b)  specifically defined a geologic structure to  include

any   structural   and/or  stratigraphic   entrapping   mechanism

containing  one or more intervals, zones, strata, formations,  or

fault  blocks.32   Because  this  definition  allows  a  trapping

mechanism (such as the mechanism common to the Kuparuk  C  sands)

to   contain   multiple  accumulations  of  oil,  it   does   not

automatically require the department to award a discovery royalty

to every newly discovered trap in the same entrapping mechanism.

          It  follows  that the commissioners decision  does  not

conflict  as  a matter of law with the definition of  a  geologic

structure  set out in former 11 AAC 505.741(b).  The commissioner

found that the Midnight Sun Reservoir did not have a geologically

different   entrapping  mechanism  from  other  Kuparuk   C   oil

accumulations; a geologic structure is defined by the  regulation

primarily  as  an entrapping mechanism.  The fact  that  such  an

entrapping  mechanism may contain multiple geologic features  and

formations  does  not make it any less a single  structure.   The

plain text of the regulation does not demand that each one of the

structures intervals, zones, strata, formations, or fault  blocks

contain  oil.  The commissioners decision thus falls  within  the

limits defined in former 11 AAC 505.741(b).

          The  corporations  also contend that the  commissioners

decision  cannot be reconciled with the departments own decisions

in  other discovery-royalty cases involving the Kuparuk  C  sands

specifically  the  Niakuk and Pt. McIntyre  decisions.   But  the

commissioner  fully  considered  department  precedent   in   his

decision.   He  distinguished the Niakuk award from  the  present

case,  noting that the department was not bound to recognize  the

          Midnight Sun as a new discovery simply because its location had

been omitted from the area that the Niakuk decision described  as

the  Niakuk  structure.   This finding  appropriately  recognizes

that,  under  Alaskas  regulations and  federal  law  alike,  the

boundaries  of a given geologic structure may expand or  contract

with advances in knowledge and technique.

          The   commissioner  distinguished  the   Pt.   McIntyre

decision  on slightly different grounds, observing that  the  Pt.

McIntyre well involved substantial commercial risk.  As  we  have

already  indicated,  commercial risk is a permissible  factor  to

consider  in  determining  whether a  particular  discovery  lies

within an already known geologic structure.33

          Accordingly, we conclude that the commissioner did  not

base  his decision on a flawed legal standard.  We turn  next  to

the  corporations  additional  criticisms  of  the  commissioners

decision.

          The  corporations argue that the commissioners  failure

to  designate  the Midnight Sun Reservoir as a separate  geologic

structure conflicts with the departments actual treatment of  the

area   before   and  after  the  discovery  well   was   drilled.

Specifically,  the  corporations contend, no information  existed

before  drilling  that  would have allowed  Midnight  Sun  to  be

included  in  any recognized participating area;  yet  after  the

discovery,  the  department approved  Midnight  Sun  as  its  own

participating  area.  But this argument conflates distinct  rules

governing  discovery and participation.  Participating areas  are

defined  by  regulation to include only lands that are reasonably

estimated . . . to be capable of producing . . . hydrocarbons  in

paying quantities.34 As the state explains, unit and participation

areas are created by multiple developers with access to the  same

reservoir;   their  purpose  is  to  maximize   production   from

individual reservoirs without waste.35  Because the criteria  for

participating areas differ in purpose and definition  from  those

for awarding discovery royalty rights, a locations exclusion from

          or approval as a participating area does not determine its status

as a separate geologic structure.

          The  state additionally points out that prior decisions
by the department and federal decisions under the known-geologic-
structure  standard  have  denied  discovery  royalty  awards  to
isolated  reservoirs  that  are  nonetheless  part  of  the  same
geologic  structure.   The  record  supports  the  states  point,
establishing  that  the departments present  application  of  the
known-geologic-structure  standard   is   consistent   with   its
historical   interpretation  of   that   standard.    Here,   the
commissioner  similarly found that Midnight Sun  was  a  separate
accumulation included within the larger Kuparuk C structure.   He
noted  that  all the Kuparuk C sands share the same stratigraphic
elements   and   structural   characteristics.    Because   these
determinations incorporate factual findings, we must  affirm  the
commissioners decision as long as it is supported by  substantial
evidence.36   For as we recognized in Exxon Corp. v. State,  when
the finder of fact must determine the meaning of a contract based
on  extrinsic  evidence that raises conflicting  inferences,  our
inquiry  is  limited to determining whether the  trier  of  facts
choice of inferences is supported by substantial evidence. 37  On
reviewing  the  record  here, we find that  substantial  evidence
supports the commissioners decision.
     C.   Due Process
          The   companies  separately  argue  that  due   process
required the superior court to conduct a de novo hearing.   Under
11   AAC   02.050(a)  (2004),  [t]he  department  will,  in   its
discretion,  hold  a  hearing when  questions  of  fact  must  be
resolved.  According to 11 AAC 02.050(b), the procedure for  such
a  hearing will be determined by the department on a case-by-case
basis.38
          The  corporations  argue that they  were  denied  their
procedural   due  process  rights  in  the  hearing  before   the
commissioner because the commissioner (1) prohibited counsel from
participating,   (2)   prohibited  cross-examination,   and   (3)
          prohibited all parties from presenting post-hearing oral or
written  arguments  concerning the weight of the  evidence.   The
corporations  note  that when a traditional contract  dispute  is
filed  in  the  superior court, the regular rules  pertaining  to
discovery,  the  conduct  of trials, burden  of  proof,  and  the
interpretation  of  contracts apply.  They also  argue  that  the
balancing test enunciated in Mathews v. Eldridge39 tilts in their
favor.  That test requires consideration of three factors:
          First,  the  private interest  that  will  be
          affected by the official action; second,  the
          risk  of  an  erroneous deprivation  of  such
          interest through the procedures used, and the
          probable  value,  if any,  of  additional  or
          substitute    procedural   safeguards;    and
          finally,  the Governments interest, including
          the  function  involved and  the  fiscal  and
          administrative burdens that the additional or
          substitute   procedural   requirement   would
          entail.[40]
          
          Applying   this   test  to  the   present   case,   the
corporations maintain that a valuable contract right is at stake,
the  procedural constraints created a serious risk  of  erroneous
deprivation of Lessees valuable contract right, and allowing  the
additional argument would have converted the one-day hearing into
only  a  two-day  hearing  akin to  the  limited  trial  de  novo
requested  by  the  Lessees  of  the  Superior  Court.   As   the
corporations  correctly  claim, the private  contract  rights  at
issue   are   significant.    The  cost   of   a   hearing   with
representation, cross-examination, and oral argument on the state
would  have been relatively small.  Furthermore, the value of  an
attorneys representation to safeguard due process is certain.
          But  our  review of the record convinces  us  that  the
commissioners failure to allow representation at the corporations
hearing  amounted  to harmless error.  The corporations  made  no
specific  offer  of proof to establish potential prejudice  below
and  have  failed to identify any substantial prejudice in  their
current  briefing.  While they advance a general  assertion  that
the  presence  of  counsel would have enabled them  to  test  the
credibility of witnesses through cross-examination, the case does
          not appear to turn on credibility determinations, and the
corporations point to no specific evidence that might  have  been
susceptible to a different interpretation.  Similarly, we fail to
see  how  the corporations were prejudiced by their inability  to
have   counsel   present   at  opening  and   closing   arguments
particularly since the commissioner allowed the parties to submit
voluminous legal briefing.  On this record, we conclude that  the
procedural error was harmless.
IV.  CONCLUSION
          Because  the  commissioners decision  is  supported  by
substantial  evidence and comports with the lease  and  governing
Alaska law, and because the corporations have failed to show that
they   suffered  substantial  prejudice  from  the  commissioners
refusal  to  allow their counsel to participate  in  the  hearing
before  the  commissioner,  we  AFFIRM  the  commissioners  order
denying the corporations application for a discovery royalty.
_______________________________
     1    Ch. 169, SLA 1959.

     2    Former AS 38.05.180(a) (1959) (repealed 1969).

     3    See Former 11 Alaska Administrative Code (AAC) 505.74 -
11 AAC 505.748 (1964), (amended and renumbered as 11 AAC 83.200 -
11 AAC 83.230 (1974), and repealed in 1979).

     4    Former 11 AAC 517.1 (1960).

     5    Id.

     6    Former 11 AAC 505.74-.748 (1964).

     7    Former 11 AAC 505.744 (1964).

     8    Former AS 38.05.180(a) (1959).

     9    Former 11 AAC 505.741(b) (1964).

     10    30 U.S.C.  181-287 (2004).

     11    Id. at  226(b).

     12     Arkla  Exploration Co. v. Texas Oil & Gas Corp.,  734
F.2d 347, 349 (8th Cir. 1984).

     13     Emmet  A.  Finley, The Definition of  Known  Geologic
Structures  of  Producing  Oil and Gas  Fields,  U.S.  Geological
Survey Circular 419, 1 (1959).

     14    See ch. 91,  2, SLA 1967; ch. 65,  1, SLA 1969.

     15    Paragraph 12 of the lease states:

          12.    REDUCTION   OF   ROYALTY   RATES   FOR
          DISCOVERY.   If  Lessee shall drill  on  said
          land  and make the first discovery of oil  or
          gas  in commercial quantities in any geologic
          structure, the royalty rate under this  lease
          shall,  instead  of the rates  prescribed  in
          Paragraph 11, be five per cent for  a  period
          of  ten  years  following the  date  of  such
          discovery,  and thereafter the royalty  rates
          shall  be  those prescribed in Paragraph  11.
          If   this  lease  is  committed  to  a   unit
          agreement approved or prescribed by Lessor as
          provided  in  the regulations, the  five  per
          cent royalty rate shall not apply to all, but
          only,  the production allocated to this lease
          under such agreement.
          
     16      Unit   agreements   and  participating   areas   are
organizational  schemes  approved by the  Department  of  Natural
Resources to efficiently extract oil from a common reservoir that
is the subject of multiple leases.  See 11 AAC 83.303 (2004).

     17     11  AAC  02.030  (2004) provides the  procedures  for
seeking  [a]n  appeal  or  request  for  reconsideration   of   a
department  decision.  Beyond a written request,  the  regulation
allows the petitioner to include a request for an oral hearing  .
.  .  ;  the  appellant  may include a request  for  any  special
procedures  to be used at the hearing; the appeal or request  for
reconsideration must describe the factual issues to be considered
at the hearing. 11 AAC 02.030(a)(13).  Furthermore, [a]t the time
an  appeal is filed, and up until the deadline set out in 11  AAC
02.040(a)  to file the appeal, an appellant may submit additional
written material in support of the appeal, including evidence  or
legal argument. 11 AAC 02.030(b).

     18    11 AAC 02.050 reads, in its entirety:

          (a)   The department will, in its discretion,
          hold a hearing when questions of fact must be
          resolved.
          
          (b)  The hearing procedure will be determined
          by the department on a case-by-case basis. As
          provided in 11 AAC 02.030(a)(13), any request
          for  special procedures must be included with
          the request for a hearing.
          
          (c)  In a hearing held under this section
          
          (1)  formal rules of evidence need not apply;
          and
          
          (2)  the hearing will be recorded, and may be
          transcribed at the request and expense of the
          party requesting the transcript.
          
     19    Finley, supra note 13.

     20     Alyeska Pipeline Serv. Co. v. DeShong, 77 P.3d  1227,
1231 (Alaska 2003).

     21    Jager v. State, 537 P.2d 1100, 1107 n.23 (Alaska 1975).

     22    Former 11 AAC 505.741(b) (1964).

     23    Tesoro Alaska Petroleum Co. v. Kenai Pipe Line Co., 746
P.2d 896, 903 (Alaska 1987).

     24    See Pan Am. Petroleum Corp. v. Shell Oil Co., 455 P.2d
12,  19-24 (Alaska 1969) (where statute suggests no criteria  for
discovery  in  commercial  quantities, the  departments  decision
reviewed for reasonable basis).

     25     The  corporations also contend that the commissioners
decision  is  post-hoc contract modification, invalid  under  the
contract  clauses  of the federal and state  constitutions.   See
U.S.  Const. art. I,  10, cl. 1; Alaska Const. art. I,  15.   The
lease  grants the department the authority to determine discovery
royalty   awards   subject   to  the   regulations.    Thus   the
commissioners   decision  does  not  amount  to   a   legislative
impairment of contract of constitutional dimensions.  See,  e.g.,
Exxon Corp. v. State, 40 P.3d 786, 789 (Alaska 2001).

     26    Former 11 AAC 505.741(b) (1964) (emphasis added).

     27     See  former  AS 38.05.180(a) (1959);  former  11  AAC
505.742 (1964).

     28     See,  e.g., B.A. Wilford, 110 IBLA 154,  169  (1989);
Robert  G.  Lynn, 61 IBLA 153, 155 (1982) (The initial boundaries
of  a  [known  geologic  structure] are  not  preclusive  of  the
possibility of future changes.).

     29     Emmet  A.  Finley, The Definition of  Known  Geologic
Structures  of  Producing  Oil and Gas  Fields,  U.S.  Geological
Survey Circular 419, 1 (1959).

     30    Source Petroleum Co., 112 IBLA 184 (1989).

     31     Arkla  Exploration Co. v. Texas Oil & Gas Corp.,  734
F.2d  347, 360-61 (8th Cir. 1984) ([R]elative risk of exploration
and    exploration   interest   lie   at   the   heart   of   the
competitive/noncompetitive  leasing  dichotomy  in  the  [Mineral
Leasing Act].).

     32    Former 11 AAC 505.741(b) (1964).

     33    Arkla Exploration, 734 F.2d at 360-61.

     34    11 AAC 83.351(a) (2004).

     35    See also Exxon Corp. v. State, 40 P.3d 786, 788 (Alaska
2001).

          A  unit  agreement is a contract between  the
          department  and lessees that allows  for  the
          efficient  development of  a  reservoir  that
          underlies  multiple leases owned by different
          lessees.   The various lessees join  together
          in  exploration  and drilling,  and  allocate
          costs and production.
          
     36     Commercial Fisheries Entry Commn v. Baxter, 806  P.2d
1373, 1374 (Alaska 1991).

     37    40 P.3d 786, 792 (Alaska 2001).

     38    The full text of 11 AAC 02.050 is set out above in note
18.

     39    424 U.S. 319 (1976).

     40    Id. at 335.