This dispute arose from royalties owed to the federal government for natural gas produced on federal leases in New Mexico. Devon Energy Production Company, L.P. was authorized to deduct certain costs incurred in treating and transporting gas for resale, but could not deduct costs associated with gathering gas or putting it in 'marketable condition.' In 2009, state officials audited Devon's production and disallowed deductions for costs related to removing carbon dioxide from coalbed methane, ordering Devon to pay over $2.8 million or provide further proof. Devon objected, arguing the agency acted arbitrarily and capriciously. The agency rejected this objection without addressing a prior settlement agreement between a related Devon entity and the government that had established a formula for calculating these exact costs. The district court affirmed the agency's decision, but the Tenth Circuit reversed.
The court applied the arbitrary and capricious standard under the Administrative Procedure Act, which requires an agency to consider important aspects of the problem. The court found that the settlement agreement constituted a legally and factually important part of the problem because it controlled over conflicting regulations and addressed over 80% of the disputed royalties. The agency's failure to mention the settlement agreement rendered its decision unreasonable. The government argued the error was harmless because the settlement involved a different corporate entity and had expired. The court rejected the entity argument because the administrative record lacked documents proving the relationship between the entities, preventing meaningful evaluation. Regarding expiration, the court found the settlement agreement ambiguous regarding whether the treatment rate expired with the transportation rate. Because the duration of the rate was debatable and the outcome was not clear and indisputable, the court could not affirm on alternative grounds. The court also declined to decide whether to vacate the agency's decision immediately, instead remanding to the district court to determine the appropriate remedy based on the seriousness of the deficiency and disruptive consequences.
The agency's order denying cost deductions is effectively vacated, and the case returns to the district court to determine the proper remedy. The district court must decide whether to vacate the agency's decision entirely or remand to the agency for a new determination. If the case is remanded to the agency, Devon Energy will likely be able to apply the settlement agreement's formula to calculate deductions for over 80% of the disputed royalties, potentially reducing the amount owed. The decision clarifies that agencies cannot ignore binding settlement agreements that resolve similar factual and legal issues, even if the corporate entities differ slightly or the agreement's expiration terms are ambiguous.