Courts Uphold Supplemental Assessment of Wells and Related Facilities/Improvements; and Validate Use of Cost Approach

The County of Kern Tax Assessor’s (“Assessor”) use of the cost approach to value to appraise new oil and gas wells for the purpose of levying supplemental assessments has been upheld by the Fifth District Court of Appeal. In Chevron USA, Inc. v. County of Kern (October 28, 2014, F066273) ___Cal.App.4th ___ [2014 Daily Journal D.A.R. 14,553], the Court of Appeal affirmed the Kern County Assessment Appeals Board's (“Board”) decision which upheld the Assessor’s cost method for valuing new oil and gas wells, and found that the Board’s decision was a valid exercise of its discretion.


Chevron USA, Inc. ("Chevron") operates numerous oilfields in the County of Kern (“Kern”), many of which have been in operation since the late 1800s or early 1900s. During the tax years at issue, 2006-07, 2007-08 and 2008-09, Chevron drilled and completed over 1,800 wells on its Kern oilfields, at a cost of over $500,000,000.  All of the wells drilled were new wells; many of which were drilled to “recover new reserves that were not being produced by existing wells.”  Chevron, however, asserted that new wells were not subject to supplemental assessment and that many of the wells were “replacement wells” (as defined by Chevron) designed to continue production by replacing existing wells that had been damaged or impeded in production; and that such wells were not subject to supplemental assessment. in whole or in part.

Prior to 2006, the Assessor issued supplemental assessments as a percentage of the value of new wells. However, beginning in 2006, the Assessor changed its policy, and began to issue supplemental assessments on new wells based on 100 percent of the value of such new construction, using the cost approach to value to determine the well's taxable value.

Chevron paid the taxes under protest, and submitted a request for equalization to the Board, challenging, in pertinent part, (1) whether the cost approach to value is the correct method to value new wells, (2) whether the new wells can be classified as new construction subject to supplemental assessment, (3) whether the new wells add value to the properties involved, and (4) whether the assessments constitute double taxation. The Assessor opposed all of Chevron's arguments, asserting that his office had properly assessed each and all of the new wells, and had properly determined the taxable value of the wells. The Board found in favor of the Assessor on all of the material issues. Chevron and its parent corporation Chevron Corporation (“Corp”) subsequently filed suit in the superior court for a refund of the taxes.

The Superior Court ruled in Chevron’s favor on the valuation method issue, finding that the cost approach was inappropriate, but ruled for the Assessor and County of Kern (collectively "Kern") on most of the remaining issues, holding in abeyance the issue of double taxation, and remanding the matter to the Board to revise the method of valuation for the supplemental assessments.

Kern also argued that Chevron and Corp lacked standing to bring the suit, as it appeared that Chevron had not paid the taxes at issue, and that Corp had failed to participate in the underlying equalization hearing and had therefore failed to exhaust its administrative remedies.  Based on the evidence presented, the Superior Court found that Chevron had standing, but that Corp did not.

Kern appealed the trial court judgment and argued that Chevron did not have standing to bring the tax refund action, and that the Board did not act arbitrarily, abuse its discretion, or otherwise act unlawfully when it approved and adopted supplemental assessment of the new wells and the Assessor’s cost approach to value methodology. Chevron cross-appealed arguing, essentially, that new wells were exempt from supplemental assessment.


Of significant importance, the Court considered Kern’s appeal regarding the valuation method. Applying a standard of deference to the Board, the Court determined that the Assessor had properly selected and applied a permissible valuation method for calculating the supplemental assessments for the new wells; thereby validating the use of the cost approach to value and the imposition of supplement assessments.

Tax valuation for oil and gas properties is regulated by the State Board of Equalization pursuant to Rule 468. Under Rule 468(c), oil and gas properties are “unique” and “require the application of specialized appraisal techniques.” Pursuant to subsection (c), Assessors use a “market value” method of appraising oil properties. Under Rule 468(c), Assessors first determine the market value of the property, and then separately determine the “mineral interest” by subtracting the value of the land and improvements from the market value of the land to obtain the value of the mineral reserves (“reserves”). The base year value of the non-mineral property interest is fixed by Proposition 13, but the taxable value of the mineral interest is subject to re-evaluation based on changes to the proved reserves. For oil and gas properties, the value of new construction, including wells, is added to the base year value of the non-mineral property value upon completion of construction.

In support of his position, the Assessor presented evidence utilizing the income approach to value showing the value of a hypothetical oil field with one well, which compared the value of the field one day before a new well is completed with the value the day of completion, indicating the change in value of the property is equivalent to the cost to construct and complete the new well, thereby corroborating and supporting the use of the cost approach.

Chevron argued that the value of a new well should be calculated as the difference in the income approach value of the entire property on the previous annual lien date (January 1st)  and the entire property on the day of completion. Chevron further argued that since the Assessor used an income valuation method for determining the base year value for properties, the supplemental assessments needed to use a similar valuation method to be compatible with Rule 468. But, the Court rejected Chevron's argument, noting that the income approach was being used to determine the value of the mineral rights, and that the non-mineral property values were set using the cost approach. In any event, the Assessor’s expert testified that the value of the new well should be the same using either the cost or income valuation methods, stating the value of the well equals the cost to drill and complete the well because the cash flow prior to the drilling should reflect the anticipated capital expense of the well, and the cash flow after the drilling will reflect the reduction in anticipated capital expense. Chevron conceded that the Assessor was using a cost approach to calculate the non-mineral property values, and in fact admitted that it would be virtually impossible to run a cash flow for the each of the new wells, calling the task "Herculean".

The Court also rejected Chevron’s argument that the value of a replacement well should be tied to change in reserves accessible due to the well, and rejected Chevron’s cross-appeal finding that it raised issues already addressed by the Court in Kern’s appeal.

The Court concluded by finding that the Board did not act arbitrarily, in excess of its discretion or contract to law by approving and adopting the Assessor’s cost method for valuing the new wells for supplemental assessment and levying such assessments, and affirmed the Board’s decision in all respects. The Court also determined that Chevron had failed to meet its burden of proof in connection with its position on several of the grounds for exemption from assessment asserted by Chevron.

The Court of Appeal also found, based upon the evidence presented, that Chevron had standing by relying on the underlying purpose of Section 5140. The Court determined that the purpose of Section 5140 is to ensure that only the person who pays a tax is entitled to refund, and to prevent the likelihood of double refund by payment to both the owner and the party who paid the tax. The Court found that, in this case, there was no confusion about who sought the refund (Chevron), and no likelihood of double refund, so the purpose of the statute could be accomplished by allowing Chevron to seek reimbursement.

What This Case Means to You

The Courts have confirmed that the supplemental assessment of new wells and surface facilities/improvements on mineral resource properties is valid; and can be determined using the cost approach to value.  As a result, many millions of dollars in supplemental assessments may be made in counties which have such properties and have not previously made such assessments.  Counties may wish to check their policy on such assessments. 


If you have any questions concerning this Legal Alert, please contact the following from our office, or the attorney with whom you normally consult.

Brett L. Price | 661.864.3800

William T. Chisum | 916.321.4500

Maggie W. Stern | 916.321.4500