226 F.3d 1138 (10th Cir. 2000), 99-1147, Atlantic Richfield Co v Farm Cred Bnk Wichita

Docket Nº:99-1147, 99-1148, 99-1154, 99-1183
Citation:226 F.3d 1138
Party Name:ATLANTIC RICHFIELD COMPANY, Plaintiff-Counter-Defendant-Appellee, v. THE FARM CREDIT BANK OF WICHITA, formerly known as the Federal Land Bank of Wichita, Defendant-Counter-Claimant-Appellant, and STANLEY A. MOLLERSTUEN; HAL A. McVEY; HELEN D. McVEY; CAROL KOSCOVE, Defendants-Counter-Claimants, ALFRED GARCIA; NADDIE GARCIA; EDWARD GARCIA; MARY RUTH
Case Date:September 13, 2000
Court:United States Courts of Appeals, Court of Appeals for the Tenth Circuit
 
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Page 1138

226 F.3d 1138 (10th Cir. 2000)

ATLANTIC RICHFIELD COMPANY, Plaintiff-Counter-Defendant-Appellee,

v.

THE FARM CREDIT BANK OF WICHITA, formerly known as the Federal Land Bank of Wichita, Defendant-Counter-Claimant-Appellant,

and

STANLEY A. MOLLERSTUEN; HAL A. McVEY; HELEN D. McVEY; CAROL KOSCOVE, Defendants-Counter-Claimants,

ALFRED GARCIA; NADDIE GARCIA; EDWARD GARCIA; MARY RUTH SALAZAR-TIER; PEGGY GARCIA; JACQUIE GARCIA; CATHERINE VOELKERDING; MANUELITA BECK; ANNA M. MARTINEZ; GERALDINE VELASQUEZ, Intervenors,

and

NATIONAL ASSOCIATION OF ROYALTY OWNERS, INC., Amicus Curiae.

ATLANTIC RICHFIELD COMPANY, Plaintiff-Counter-Defendant-Appellant,

v.

THE FARM CREDIT BANK OF WICHITA, formerly known as the Federal Land Bank of Wichita; CAROL KOSCOVE, Defendants-Counter-Claimants-Appellees,

and

STANLEY A. MOLLERSTUEN; HAL A. McVEY; HELEN D. McVEY, Defendants-Counter-Claimants,

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ALFRED GARCIA; NADDIE GARCIA; EDWARD GARCIA; MARY RUTH SALAZAR-TIER; PEGGY GARCIA; JACQUIE GARCIA; CATHERINE VOELKERDING; MANUELITA BECK; ANNA M. MARTINEZ; GERALDINE VELASQUEZ, Intervenors-Appellees,

and

NATIONAL ASSOCIATION OF ROYALTY OWNERS, INC., Amicus Curiae.

ATLANTIC RICHFIELD COMPANY, Plaintiff-Counter-Defendant-Appellee,

v.

THE FARM CREDIT BANK OF WICHITA, formerly known as the Federal Land Bank of Wichita; STANLEY A. MOLLERSTUEN; HAL A. McVEY; HELEN D. McVEY, Defendants-Counter-Claimants,

and

CAROL KOSCOVE, Defendant-Counter-Claimant-Appellant,

ALFRED GARCIA; NADDIE GARCIA; EDWARD GARCIA; MARY RUTH SALAZAR-TIER; PEGGY GARCIA; JACQUIE GARCIA; CATHERINE VOELKERDING; MANUELITA BECK; ANNA M. MARTINEZ; GERALDINE VELASQUEZ, Intervenors,

and

NATIONAL ASSOCIATION OF ROYALTY OWNERS, INC., Amicus Curiae.

ATLANTIC RICHFIELD COMPANY, Plaintiff-Counter-Defendant-Appellee,

v.

DARWIN H. SMALLWOOD, Defendant,

and

THE FARM CREDIT BANK OF WICHITA, formerly known as the Federal Land Bank of Wichita; STANLEY A. MOLLERSTUEN; HAL A. McVEY; HELEN D. McVEY; CAROL KOSCOVE, Defendants-Counter-Claimants,

ALFRED GARCIA; NADDIE GARCIA; EDWARD GARCIA; MARY RUTH SALAZAR-TIER; PEGGY GARCIA; JACQUIE GARCIA; CATHERINE VOELKERDING; MANUELITA BECK; ANNA M. MARTINEZ; GERALDINE VELASQUEZ, Intervenors-Appellants,

and

NATIONAL ASSOCIATION OF ROYALTY OWNERS, INC., Amicus Curiae.

Nos. 99-1147, 99-1148, 99-1154, 99-1183

United States Court of Appeals, Tenth Circuit

September 13, 2000

APPEAL FROM UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO (D.C. No. 95-Z-1767)

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Steven R. Rider (E. Dwight Taylor with him on the brief), Rider & Woulf, P.C., of Aurora, Colorado, for The Farm Credit Bank of Wichita.

Anthony J. Shaheen (Gail L. Wurtzler, Charles L. Kaiser, and William A. Bianco with him on the brief), Davis, Graham & Stubbs LLP, of Denver, Colorado, for Atlantic Richfield Company.

George W. Mueller, Burns, Wall, Smith and Mueller, P.C., of Denver, Colorado, for Carol Koscove.

H. Paul Cohen (Thomas W. Niebrugge, Lindquist, Vennem & Christensen, with him on the brief), of Denver, Colorado, for Alfred Garcia, Naddie Garcia, Edward Garcia, Mary Ruth Salazar-Tier, Peggy Garcia, Jacquie Garcia, Catherine Voelkerding, Manuelita Beck, Anna M. Martinez, and Geraldine Velasquez.

Robin Stead and Donald F. Heath, Jr., Stead & Heath, P.C., of Oklahoma City, Oklahoma, on the brief for National Association of Royalty Owners, Inc., amicus curiae.

Before BRISCOE, McWILLIAMS, and ALARCON1, Circuit Judges.

BRISCOE, Circuit Judge.

This complex litigation involves several oil and gas leases. The lessee, plaintiff Atlantic Richfield Company ("ARCO"), filed a claim for declaratory relief. The defendant lessors the Farm Credit Bank of Wichita ("FCB"), Carol Koscove ("Koscove"), and members of the Garcia family ("the Garcias") countered by filing a variety of counterclaims against ARCO. The district court issued a series of rulings resolving all of the parties' claims prior to trial. ARCO appeals three of these rulings, and the defendants appeal at least seven others. We exercise jurisdiction pursuant to 28 U.S.C. § 1291, affirm in part, and reverse in part.2

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I. BACKGROUND

In the 1970s, ARCO discovered that carbon dioxide ("CO2") can be used to increase recovery from certain types of oil reservoirs. This process is commonly referred to as "tertiary recovery" or "enhanced oil recovery" ("EOR"). Joint Appendix ("Jt. App.") at 95-96 (¶¶ 22-23), 2447 (¶ 5), 7106-07. In 1975, ARCO acquired oil and gas leases for lands in Huerfano County, Colorado with the potential for CO2 production. FCB, Koscove, and the Garcias own royalty interests in these leases, which were unitized3 into a "Sheep Mountain Unit" ("SMU") for the exploration, development, and production of CO2. Id. at 97 (¶ 27), 1700. Because the nearest market is approximately 400 miles away, ARCO constructed a pipeline (the "Pipeline") to transport the CO2 from the SMU to the Permian Basin in West Texas.

The parties' leases provide the starting point for all royalty calculations. The Garcias' lease expressly contemplates some form of a transportation deduction and states that royalties shall be based on market values determined "at the mouth of the well":

If Lessee sells gas at the mouth of the well, Lessee shall pay Lessor as royalty 1/8 of the proceeds from such sale. If Lessee sells gas at a point other than at the mouth of the well, Lessee shall pay Lessor as royalty on said gas 1/8 of the proceeds from such sale, after deducting from such proceeds the reasonable cost of preparing said gas for market, including but not limited to the cost of any necessary compression and the cost of transporting said gas to the point of sale. Where gas is not sold by Lessee, but is used by Lessee for any purpose other than the manufacture of gasoline or any other product, Lessee shall pay Lessor as royalty on said gas 1/8 of the market value of said gas, said value to be determined at the mouth of the well, and in determining said market value, there shall be deducted any cost of any necessary compression, the cost of transporting said gas to the point of use, and any other reasonable cost for preparing such gas for use.

Id. at 276. FCB's lease is silent on the deductibility of transportation expenses. Like the Garcias' lease, however, the 1975 version of FCB's lease states that royalties shall be based on market values determined "at the mouth of the well":

The lessee shall pay to lessor for gas produced from any oil well and used by the lessee for the manufacture of gasoline or any other product as royalty 1/8 of the market value of such gas at the mouth of the well: if said gas is sold by the lessee, then as royalty 1/8 of the proceeds of the sale thereof at the mouth of the well.

Id. at 345. FCB's lease was amended and "corrected" in 1977. Among other things, the corrected amendment changes the royalty rate from 1/8 to 3/16, id. at 348, and adds a provision entitled "Gas Pricing":

Anything to the contrary above stated notwithstanding, the price which Lessee shall pay for gas produced pursuant to this lease when Lessor is not exercising its option to take in kind shall be respectively for each chemical or generic type of gas (for example, carbon dioxide gas, or hydrocarbon gas, etc.), as the case may be, the highest current market price at the time the gas is produced and sold of (1) the highest paid in Huerfano County, (2) the current market price established by the Federal Government for its share of the gas, or (3) the amount received by Atlantic for its share of the gas.

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Id. at 352. The amendment also inserts the following language into the lease's granting clause: "The word 'gas' as used in this lease shall include gases of all kinds, whether hydrocarbon gas or gases or nonhydrocarbon gas or gases, including but not limited to carbon dioxide gas, and any mixture or mixtures of any such gases." Id. at 348.

In addition to the lease contracts, the question also arose as to whether ARCO's relationship with the Exxon Company ("Exxon") affected the parties' royalty obligations. ARCO executed an "Agreement on Principles" ("AOP") in 1981 that conveyed to Exxon a 50% interest in the Pipeline and the CO2 produced at the SMU. Id. at 4025, 4030. Under the AOP, ARCO pays all royalties on CO2 produced at the SMU. Exxon then reimburses ARCO for royalties paid on Exxon's share of the gas. Exxon agreed in the AOP to pay the first $128.7 million to develop the SMU facilities, the first $120 million to develop the Pipeline, and 50% of all costs thereafter.4 By the defendants' calculation, ARCO ultimately contributed less than $50 million in capital toward the SMU and the Pipeline. This $50 million contribution represented about 15% of the companies' combined capital expenditure, which amounted to more than $285 million.

As intended, CO2 from the SMU is sold, used in kind, or exchanged to increase oil production in West Texas. To determine the "wellhead" value of the CO2 and the lessors' royalties, ARCO uses a "work back" or "net back" method. ARCO calculates the wellhead value of the CO2 by subtracting transportation and conditioning costs from the value of the CO2 in the West Texas market. The costs deducted by ARCO fall into three categories: (1) operations and maintenance costs; (2) depreciation costs, which include interest during construction ("IDC"); and (3) cost of capital ("COC"). ARCO defines IDC as the cost of money used to build a...

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