Diamond Shamrock Exploration Co. v. Hodel

Decision Date17 August 1988
Docket Number87-4069,Nos. 87-3195,s. 87-3195
Citation853 F.2d 1159
PartiesDIAMOND SHAMROCK EXPLORATION CO., Plaintiff-Appellant, v. Donald P. HODEL, Secretary of the Interior and William C. Bettenberg, Director, etc., Defendants-Appellees. CITIES SERVICE OIL AND GAS CORPORATION, et al., Plaintiffs-Appellants, v. Donald P. HODEL, et al., Defendants-Appellees. MESA PETROLEUM COMPANY, Plaintiff-Appellee, v. U.S. DEPARTMENT OF INTERIOR, Defendant-Appellant.
CourtU.S. Court of Appeals — Fifth Circuit

J. Berry St. John, Jr., Deborah Bahn Price, Gene W. Lafitte, New Orleans, La., for all appellants in No. 3195.

Patricia A. Patten, Cities Service Oil and Gas, Tulsa, Okl., for Cities Service Oil and Gas.

Salvatore J. Casamassima, Exxon Co., U.S. Atty., Houston, Tex., for Exxon Co.

W.R. Buck, Dallas, Tex., for Mobil Oil Corp. and Mobil Exploration and Prod. U.S. Inc.

Shirley C. Friend, Jr., New Orleans, La., for Texaco, Inc.

Dana Contratto, Ellen T. Giannuzzi, Crowell & Moring, Washington, D.C., for Diamond Shamrock Exploration Co.

Laura E. Frossard, Rebecca A. Donnellan, Robert L. Klarquist, Attys., Dept. of Justice, Land and Natural Resources Div., Washington, D.C., S. Mark Gallinghouse Asst. U.S. Atty., New Orleans, La., for defendants-appellees in No. 87-3195.

David T. Deal, G. William Frick, General Counsel, American Petroleum Institute, Philip A. Cooney, Washington, D.C., for amicus curiae-American Petroleum Institute (They support oil companies).

John H. Conway, Jerome M. Feit, Attys., F.E.R.C., Washington, D.C., for amicus curiae F.E.R.C.

Laura E. Frossard, Atty., Dept. of Justice, Land and Natural Resources Div., Washington, D.C., Joseph S. Cage, Jr., U.S. Atty., Lafayette, La., Dirk D. Snel, Atty., Dept. of Justice, Land & Natural Resources Div., Washington, D.C., for defendant-appellant in No. 87-4069.

John H. Conway, Jerome M. Feit, Attys., F.E.R.C., Washington, D.C., for amicus curiae F.E.R.C.

Daniel Joseph, Akin, Gump, Strauss, Hauer & Feld, Jerry E. Rothrock, Washington, D.C., James R. Nieset, Plauche, Smith & Nieset, Lake Charles, La., for plaintiff-appellee in No. 87-4069.

Appeal from the United States District Court for the Western District of Louisiana.

Appeals from the United States District Court for the Eastern District of Louisiana.

Before BROWN, JOHNSON, and HIGGINBOTHAM, Circuit Judges.

JOHN R. BROWN, Circuit Judge:

The issue raised is whether payments by a pipeline-purchaser to a lessee-producer of a federal oil and gas lease pursuant to a take-or-pay clause in its gas sales contract with the pipeline-purchaser are subject to payment of a royalty when the take-or-pay payment is received, not as value for gas actually taken, but as part of the take-or-pay obligation under the contract. This is another of the now prevalent take-or-pay cases with which we and others are now frequently faced. It comes to us as consolidated appeals from conflicting judgments rendered in the Western and Eastern Districts of Louisiana (Veron and Sear, J.J., respectively). We agree with the lessee-producers that royalty payments are not due on take-or-pay payments and are only due on gas actually produced and taken. We affirm the judgment of the Western District and reverse the judgment of the Eastern District. 1

I. Proceedings Below
A. The Mesa Case

In 1973, Mesa leased submerged, offshore lands from the United States pursuant to OCSLA. 2 Under the standard government oil and gas lease, Mesa was required to pay a royalty of 16 2/3% in amount or value of "production saved, removed or sold from the leased area." Mesa thereafter sold all of the gas produced from these federal leases to Tennessee Gas Pipeline Company under an exclusive long-term contract by which all of Mesa's production was committed to the contract. The contract with the pipeline included a take-or-pay provision requiring Tennessee to take a specified amount of gas during each contract year or pay for that quantity even if not taken in full. A seven-year make-up period was provided during which Tennessee was able to credit the price of gas later taken in excess of the required minimum (referred to as "make-up gas") against earlier take-or-pay payment obligations.

Mesa periodically paid royalties to the United States through the Minerals Management Service (MMS) of the Department of the Interior (DOI) on all gas currently delivered to the pipeline. Mesa did not pay royalties on take-or-pay payments received from Tennessee. Royalties were calculated and paid only if, and only to the extent, make-up gas was taken.

After an audit, MMS ordered Mesa to pay royalties on the take-or-pay payments Mesa had received from Tennessee. Prior to this audit, Mesa had not paid royalties on take-or-pay payments. Mesa calculated and paid its royalty obligation based on payments for gas actually taken, as gas was actually taken, based on the price of gas at the time it was taken. Based on this audit, MMS also notified Mesa that interest charges would be assessed for royalties paid on make-up gas from the time the take-or-pay payment for that quantity of gas was received. This order assessing payments and interest penalties was appealed to the Director of MMS who ultimately affirmed MMS' authority to collect royalties on take-or-pay receipts. 3 The Department of the Interior, through the Assistant Secretary for Land and Minerals Management, adopted the Director's decision as the final decision of the DOI.

Mesa appealed this order in the Western District of Louisiana. Judge Veron of the Western District found that the purpose of the take-or-pay provision was to ensure Mesa a steady flow of revenue to meet operation and maintenance costs. The lease agreement between the United States and Mesa entitled the government to receive 16 2/3 percent of production saved, removed or sold from the leased areas. To the extent take-or-pay payments were made in lieu of taking gas, there was no production, and Mesa had no obligation to make royalty payments thereon. MMS was therefore without authority to collect royalties on such take-or-pay receipts. Judge Veron set aside the order which required Mesa to pay royalties on take-or-pay receipts, 647 F.Supp. 1350. The government appeals.

B. The Diamond Shamrock Cases

These cases, consolidated in the Eastern District, present virtually the same situation. Diamond Shamrock, Cities Service, Exxon, Mobil and Texaco (and various subsidiaries) are lessees under numerous leases 4 on the offshore Louisiana Outer Continental Shelf. 5 These lessees uniformly failed to pay royalties on take-or-pay payments unless make-up gas had been taken, in which case royalties were calculated and paid based on the price of the gas at the time the make-up gas was taken.

As in Mesa, the MMS ordered the lessee-producers to pay royalties on take-or-pay revenues received. It additionally assessed interest charges for late payment, asserting that the royalty payment was due at the time the take-or-pay payment was made, not the time at which the make-up gas was taken. The lessees appealed to the MMS Director, who affirmed the order. 6

Cities Service and Exxon had paid royalties on some, but not all, of their take-or-pay revenues. Exxon and Cities Service requested refunds for royalties paid on such take-or-pay revenues. The MMS denied the request. Cities Service and Exxon appealed the denial of their requests to the MMS Director. The Director affirmed the denial. 7

On cross motions for summary judgment, Judge Sear of the Eastern District treated take-or-pay payments as the equivalent of advance payments for gas, similar to an interest-free loan from the pipeline. As this raised the price of gas purchased by the pipeline, take-or-pay payments were to be taken into account in calculating the "value" of the production removed, and were subject to royalty.

Judge Sear's reasoning was based in part on the definition of "production" contained in OCSLA:

The term "production" means those activities which take place after the successful completion of any means for the removal of minerals, including such removal, field operations, transfer of minerals to shore, operation monitoring, maintenance and work-over drilling. 8

Judge Sear held that, as take-or-pay payments are intended to compensate the producer for maintenance and other activities necessary to keep wells functioning, they fall within this definition of payments for production. Consequently, Judge Sear sustained the DOI's decisions and expressly rejected the holding of the Western District in Mesa. The lessee-producers appealed. 9

II. Bird's Eye View of Oil and Gas Law
A. The Lease Itself

The standard oil and gas lease issued by the government 10 and signed by these lessee-producers is fairly straightforward. The lessee-producers are required to pay 11 the lessor-government a royalty of "16 2/3 percent in amount or value of production saved, removed, or sold from the leased area." 12 The lease further provides: "It is expressly agreed that the Secretary [of the DOI] may establish reasonable minimum values for purposes of computing royalty on products obtained from this lease, due consideration being given to the highest price paid for a part or for a majority of production of like quality in the same field, or area, to the price received by the lessee, to posted prices, and to other relevant matters. Each such determination shall be made only after due notice to the lessee and a reasonable opportunity has been afforded the lessee to be heard." The royalty payment is "due and payable monthly on the last day of the calendar month next following the calendar month in which production is obtained." 13

B. Producer-Pipeline Contract
1. Take-or-Pay

The typical producer-pipeline contract 14 provides that the pipeline will generally pay for natural gas at the maximum lawful price permitted by the Natural Gas Policy Act for the month in which the gas is produced. Gas purchases are invoiced...

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