Old Kent Bank & Trust Co. v. Amoco Production Co.

• Decision Date: 02 February 1988
• Docket Number: No. G84-1407 CA1.,G84-1407 CA1.
• Citation: 679 F. Supp. 1435
• Parties: OLD KENT BANK & TRUST COMPANY, Plaintiff, v. AMOCO PRODUCTION COMPANY, a Delaware corporation, and Gulf Oil Corporation, a Pennsylvania corporation, Defendants.
• Court: U.S. District Court — Western District of Michigan

679 F. Supp. 1435

OLD KENT BANK & TRUST COMPANY, Plaintiff, v. AMOCO PRODUCTION COMPANY, a Delaware corporation, and Gulf Oil Corporation, a Pennsylvania corporation, Defendants.

No. G84-1407 CA1.

United States District Court, W.D. Michigan, S.D.

February 2, 1988.

Dale W. Rhoades, Kurt D. Hassberger, Grand Rapids, Mich., for plaintiff.

George W. Loomis, Lansing, Mich., for defendants.

OPINION

HILLMAN, Chief Judge.

On December 20, 1984, plaintiff, Old Kent Bank & Trust Company ("Old Kent"), as trustee of the Atrium Trust, filed a five count complaint against defendants, AMOCO Production Company ("AMOCO") and Gulf Oil Corporation ("Gulf") claiming deficiencies in royalty payments respecting twenty seven oil and gas wells located in Kalkaska County. The twenty seven wells aggregate 3,060 acres. Plaintiff owns a one-sixteenth non-participating royalty in some 2,155 acres of the drilling units. Pursuant to three oil and gas leases and related conveyances, defendants have the right to obtain and sell the oil available through these twenty-seven wells.

At issue in this suit is the proper characterization of gas sales by defendants to Consumers Power Company ("CPCo") and Michigan Consolidated Gas Company ("MichCon") under the provisions of the gas lease contracts between plaintiff and defendants. Neither CPCo nor MichCon are parties to the suit. According to the leases, the method of determining the royalty amount owed varies depending on whether the gas sold by defendants to the common purchasers is sold on or off the leased premises. Currently before the court are two motions for partial summary judgment: defendants' (filed August 21, 1985) and plaintiff's (filed December 1, 1986). For the reasons discussed below, defendants' motion is denied and plaintiff's motion is granted.

I. Factual Background

The facts material to the pending motions, although somewhat complicated, are not in dispute. The oil and gas leases and conveyances pursuant to which Old Kent as trustee owns a one-sixteenth non-participating royalty in the twenty-seven wells at issue in this case were executed in 1964 and 1965.¹ Under sixteen long-term purchase contracts, defendants sell most, if not all, of the gas produced from these wells to CPCo and MichCon.²

Products produced from these wells can be divided into three general categories: "wet" gas consisting of "dry" natural gas and suspended liquid components; injected liquids; and liquids tanked and sold as condensate or crude oil. At this point in discovery, plaintiff does not dispute the appropriateness of the royalties paid on condensate and crude oil³ or, it appears, injected liquids. The dispute focuses on royalties paid on the wet gas stream. These are products produced in gaseous form and transported by means of a gas pipeline from the well to one of two processing plants. It should be noted however, that plaintiff's contention respecting the alleged improper calculation of royalties on the sale of the wet gas stream must be examined in light of two different sales and processing arrangements. I describe these two systems below.

A. The CPCo/MichCon Scenario

CPCo and MichCon purchase gas extracted from twenty-one of the twenty-seven wells and a portion of the gas extracted from the twenty-second pursuant to fourteen contracts negotiated between 1971 and 1983.⁴ Defendants Amoco and Gulf meter the gas at the well to determine volume and test it for heating value in British termal units ("Btus"). They then deliver the gas to a "wetheader system" leased and operated by the common purchasers.⁵ The wetheader system is a pipeline designed to transport wet gas.

The purchase contracts specify that title to the gas passes to the common purchasers when they take delivery and before the gas is injected into the wetheader system.⁶ The purchase price paid is based either on a stated amount per thousand cubic feet of wet gas with a Btu adjustment or at a price per million British thermal units ("MMBtu"). Under the former system the gas is valued at an established price per volumetric unit. However, if the heating content of the gas varies from 1000 Btus per cubic foot, the unit sales price is adjusted proportionately. Under the latter system a volumetrically measured quantity of wet gas is multiplied by the measured heating content of the gas. The unit of measurement is an MMBtu of gas sold.⁷ Both of these pricing methods take account of the Btu content of preprocessed wet gas which, whatever it may be, is generally too "rich" for resale by the common purchasers. Processing is required.

In the purchase contracts defendants reserve the right to process the wet stream after delivery to achieve a gas compatible with CPCo's and MichCon's needs.⁸ They also retain title to any component other than the residue gas required by the common purchasers subject to their extracting or arranging for the extraction of it.⁹ CPCo and MichCon deliver the wet gas via their wetheader system to a processing plant in Kalkaska operated by various producers including defendants. After processing, CPCo and MichCon transport a less Btu-rich residue gas to their respective service areas.¹⁰ Pursuant to the sales contract, defendants retain title to the remaining liquid hydrocarbons. Eventually defendants sell these hydrocarbons to third parties.¹¹

The common purchasers are not compensated for shrinkage incurred in delivery through the wetheader to the processing plant. However, AMOCO and Gulf do compensate them for volume and Btu content lost in processing and for the value of the liquid hydrocarbons extracted from the wet gas stream.¹² The latter amount is computed according to a mathematical formula by which manufactured liquid hydrocarbons are converted from the liquid phase back to the gaseous phase and their heating value as gas determined on a per Btu basis. The price per Btu is the same as the price per Btu paid by the common purchaser under the contract when the gas is transferred into the wetheader.¹³ AMOCO and Gulf calculate plaintiff's royalties on the basis of the amount received by them from CPCo and MichCon when the gas is transferred into the wetheader.¹⁴ They do not include the amount received from the sale of the liquid hydrocarbons in that base amount. It is this omission that forms the basis of the plaintiff's claim. In other words, plaintiff argues that it should receive royalties on the amount realized by the defendants on the sale of the liquid hydrocarbons.

B. The MichCon Scenario

Pursuant to a 1970 contract with AMOCO and a 1970 contract with Gulf, MichCon purchases the balance of the gas extracted at the twenty-second well as well as that taken from the remaining five wells.¹⁵ As with gas purchased pursuant to the fourteen contracts discussed above, title to the gas purchased by MichCon under these two contracts transfers when AMOCO and Shell deliver the gas to the common purchaser's wetheader system.¹⁶ In these contracts, however, there is no Btu adjustment. Neither is the gas priced per MMBtu.¹⁷ Furthermore, AMOCO and Gulf reserve the right to process the wet gas stream for recovery of natural gas liquids prior to, rather than after, purchase by and delivery to the common purchaser.¹⁸ If AMOCO and Gulf actually undertook predelivery processing, title to the remaining liquid hydrocarbons would remain with defendants.¹⁹ However, in the early 1970s, when these contracts were negotiated, AMOCO and Gulf did not operate the Kalkaska plant at which they process gas purchased pursuant to the CPCo/MichCon scenario.²⁰ Thus, an arrangement was arrived at whereby MichCon transports the unprocessed, wet gas through its wetheader system to a processing plant owned by Shell Oil Company.²¹ Pursuant to the arrangement between MichCon and Shell, MichCon takes the processed residue gas and Shell retains and sells the remaining liquid hydrocarbons.²² Under separate contracts between Shell and AMOCO and Shell and Gulf, Shell "reimburses" AMOCO and Gulf for the value of these hydrocarbons.²³ Under this scenario, AMOCO and Gulf calculate the amount on which plaintiff's royalties are based by adding the price received from Shell for the liquid hydrocarbons to the gross proceeds received from MichCon when the gas is transferred to the wetheader system.²⁴

C. Contentions of the Parties

All of the oil and gas leases governing both the CPCo and MichCon fact situations contain the following provision governing lessor royalties:

3. LESSOR'S ROYALTY. Lessee covenants and agrees to pay Lessor as royalty on all oil, condensate, gas, asphalt and other minerals and substances, produced, saved and sold from the Premises one-eighth of the gross proceeds, less all severance and other applicable taxes, received from the sale thereof at the mouth of the well, or,

if not sold at the mouth of the well but sold or used off the Premises or for the manufacture of gasoline or any other product, then one-eighth of the amount realized at the mouth of the well from such sales, less all severance and other applicable taxes; except that the royalty on sulphur shall be 50 cents per long ton marketed; and except that no royalty shall be paid on gas or liquids when the Premises are being used for the withdrawal of storage gas or liquids as provided in Paragraph 9 hereof.

Plaintiff currently receives royalties calculated under the first half of this provision. Characterizing the gas they deliver to MichCon and CPCo as having been "sold at the mouth of the well," AMOCO and Gulf calculate plaintiff's royalties on the basis of the gross proceeds received from MichCon and CPCo. However, plaintiff contends that royalties in both the CPCo/MichCon and MichCon scenarios should be calculated pursuant to the latter half of the provision. In other words, plaintiff argues that the wet gas stream at issue in each contract is sold "off the premises" thus requiring a royalty payment of one-eighth of the "amount realized at the mouth of the well" as...