Clough v. Williams Production Rmt Co.

• Decision Date: 08 February 2007
• Docket Number: No. 05CA0322.,05CA0322.
• Citation: 179 P.3d 32
• Parties: Genevieve CLOUGH, as Personal Representative of William F. Clough, deceased, Plaintiff-Appellee, v. WILLIAMS PRODUCTION RMT COMPANY, Defendant-Appellant.
• Court: Colorado Court of Appeals

179 P.3d 32

Genevieve CLOUGH, as Personal Representative of William F. Clough, deceased, Plaintiff-Appellee, v. WILLIAMS PRODUCTION RMT COMPANY, Defendant-Appellant.

No. 05CA0322.

Colorado Court of Appeals, Div. I.

February 8, 2007.

Certiorari Denied September 11, 2007.

Dufford, Waldeck, Milburn & Krohn, L.L.P., Nathan A. Keever, Grand Junction, Colorado, for Plaintiff-Appellee.

Davis Graham & Stubbs, LLP, Anthony J. Shaheen, Eugene A. Lang, Jr., Denver, Colorado, for Defendant-Appellant.

Opinion by Judge BERNARD.

In this case involving royalty payments under natural gas leases, defendant, Williams Production RMT Company, appeals the judgment in favor of plaintiff, William F. Clough. We affirm.

I. Background

The following facts are undisputed. Clough owns royalty interests in natural gas wells in the Piceance Basin in Garfield County, Colorado. Williams operates the wells and pays royalties pursuant to two natural gas leases. Clough sued Williams to recover unpaid royalties, claiming Williams' predecessor in interest, Barrett Resources Corporation, underpaid royalties due him by failing to account for all the gas obtained, failing to pay the full amount due for the natural gas liquids removed from the gas stream, and improperly deducting the cost of gathering, processing, and transporting the gas to the commercial marketplace from the royalty payment. Clough alleged these underpayments were a breach of the leases and a violation of the Colorado Consumer Protection Act.

The jury found Williams breached one or both of the leases and awarded Clough $4,091,561.30 in damages. The jury also found Williams violated the Consumer Protection Act and acted in bad faith.

After the verdict was returned, Clough filed a motion for trebling of damages and entry of judgment. Williams filed a motion for judgment notwithstanding the verdict and for a new trial. The trial court granted Williams' motion for judgment notwithstanding the verdict as to the Consumer Protection Act claim, denied Williams' motion for a new trial, awarded Clough prejudgment interest and costs, and denied Clough's motion to treble damages.

II. Exclusion of Pre-1992 Sales and Marketing Evidence

Williams first contends the trial court erred in excluding evidence of an offer it received in 1984 to purchase gas at the wellhead and other pre-1992 sales and marketing evidence. Williams argues its decision to reject the offer and build its own gathering system affected its post-1992 sales and marketing decisions and the deductions it took from Clough's royalty payments. We conclude the evidence was properly excluded.

A. Background of Natural Gas Regulation

To place Williams' contention in context, we begin by briefly reviewing the relevant history of the natural gas industry.

In 1938, Congress enacted the Natural Gas Act, 15 U.S.C. § 717, et seq., which authorized the Federal Power Commission to regulate pipeline rates for transportation and resale of natural gas. See Smith v. Amoco Prod. Co., 272 Kan. 58, 31 P.3d 255 (2001). However, because the Act did not require interstate pipelines to offer transportation services to third parties wishing to ship gas, "interstate pipelines [were able] to use their monopoly power over gas transportation to create and maintain monopoly power in the market for the purchase of gas at the wellhead and monopsony power in the market for the sale of gas to [local distribution companies]." Richard J. Pierce, Jr., The Evolution of Natural Gas Regulatory Policy, 10 Nat. Resources & Env't 53, 53-54 (Summer 1995) (quoted in Gen. Motors Corp. v. Tracy, 519 U.S. 278, 283, 117 S.Ct. 811, 816, 136 L.Ed.2d 761 (1997)) ("monopsony" is defined as "a market situation in which there is a single buyer for a given product or service from a large number of sellers," Webster's Third New International Dictionary 1463 (1976)).

Congress took a first step toward increasing competition in the natural gas market by enacting the Natural Gas Policy Act of 1978, 15 U.S.C. § 3301, et seq., which was designed to phase out regulation of wellhead prices charged by producers of natural gas, and to promote gas transportation by interstate and intrastate pipelines for third parties. See generally Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation; and Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol, 57 Fed.Reg. 13267, 13271 (Apr. 16, 1992) (codified at 18 C.F.R. pt. 284) (reviewing history of decontrol). Pipelines were reluctant to provide common carriage, however, when doing so would displace their own sales. See Associated Gas Distribs. v. Fed. Energy Regulatory Comm'n, 824 F.2d 981 (D.C.Cir.1987).

Thus, in 1985, the Federal Energy Regulatory Commission (FERC) promulgated Order No. 436, which contained an "open access" rule providing incentives for pipelines to offer gas transportation services. See Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol, 50 Fed.Reg. 42408 (Oct. 18, 1985) (codified at 18 C.F.R. pts. 2, 157, 250, 284, 375 & 381); Gen. Motors Corp. v. Tracy, supra.

In 1992, this evolution culminated in FERC's Order No. 636, which required all interstate pipelines to "unbundle" transportation services from their own natural gas sales and to provide common carriage services to buyers from other sources that wished to ship gas. See Pipeline Service Obligations, supra; Gen. Motors Corp. v. Tracy, supra. This implementing regulation dramatically changed the natural gas industry, because pipeline companies were "no longer permitted . . . to act as traditional merchants— buying gas at the wellhead and reselling the gas downstream — producers had to now market the gas themselves." Joyce Colson, Upstream, Midstream, Downstream — The Valuation of Royalties on Federal Oil and Gas Leases, 70 U. Colo. L.Rev. 563, 593 (Spring 1999); see Indep. Petroleum Ass'n v. DeWitt, 279 F.3d 1036 (D.C.Cir.2002) (noting the industry change); Office of Util. Consumer Counselor v. Bd. of Dirs., 678 N.E.2d 1127 (Ind.Ct.App.1997)(same); In re ANR Pipeline Co., 276 Kan. 702, 79 P.3d 751 (2003) (same); Colo. Interstate Gas Co. v. Wyo. Dep't of Revenue, 20 P.3d 528 (Wyo. 2001)(same).

The deregulation of the natural gas industry is considered the major catalyst for the current wave of royalty litigation because, before deregulation, buyers purchased gas at or near the wellhead, thereby absorbing most post-wellhead costs. Now, most gas is purchased away from the wellhead. See Owen L. Anderson, Royalty Valuation: Should Royalty Obligations Be Determined Intrinsically, Theoretically, or Realistically? (Part 1), 37 Nat. Resources J. 547 (Summer 1997). Generally, post-wellhead processing costs include gathering, dehydration, compression, and transportation costs. Creson v. Amoco Prod. Co., 129 N.M. 529, 10 P.3d 853 (Ct.App.2000); Mittelstaedt v. Santa Fe Minerals, Inc., 954 P.2d 1203 (Okla.1998).

B. Implied Covenant to Market

The industry shift is evident in Rogers v. Westerman Farm Co., 29 P.3d 887 (Colo. 2001), in which the leases at issue executed in the 1970s provided for the gas to be sold "at the wellhead," with the buyer undertaking the performance of the gathering, compression, and dehydration necessary for the gas to enter the pipeline. However, leases amended in the late 1980s and early 1990s provided for sale of the gas away from the well.

Against the background of the changing natural gas industry, the supreme court in Rogers was called upon to decide whether certain natural gas leases provided for the allocation of post-wellhead costs between the working interest owner and the royalty interest owner. All the leases contemplated that royalties were to be computed "at the well" or "at the mouth of the well." Although the court recognized other jurisdictions had ruled "at the well" language is sufficient to provide for sharing of post-wellhead costs, see Schroeder v. Terra Energy, Ltd., 223 Mich.App. 176, 565 N.W.2d 887 (1997); Judice v. Mewbourne Oil Co., 939 S.W.2d 133 (Tex.1996), it declined to follow them and concluded the leases were silent on the allocation of post-wellhead costs. Rogers v. Westerman Farm Co., supra, 29 P.3d at 901.

The court in Rogers turned to its earlier decision in Garman v. Conoco, Inc., 886 P.2d 652 (Colo.1994), which held that the duty to market is a covenant implied in every oil and gas lease, and where an oil and gas lease is silent on the allocation of post-wellhead costs, the implied covenant to market must be considered in determining the rights of the working interest owner and royalty interest owner. Thus, the court in Garman concluded, "[T]he implied covenant to market obligates the lessee [working interest owner] to incur those post-production costs necessary to place gas in a condition acceptable for market. Overriding royalty interest owners are not obligated to share in these costs." Garman v. Conoco, Inc., supra, 886 P.2d at 659.

The supreme court did not define marketable condition in Garman, but it did so in Rogers by stating: "[T]he theory of the first-marketable product is helpful in guiding our definition of marketability, and what is meant by gas being in a marketable condition. Thus . . . we look to the first-marketable product rule for guidance, but do not adopt it in its entirety." Rogers v. Westerman Farm Co., supra, 29 P.3d at 904. The first-marketable product rule states, "[T]he point where a marketable product is first obtained is the logical point where the exploration and production segment of the oil and gas industry ends, is the point where the primary objective of the lease contract is achieved, and therefore is the logical point for the calculation of royalty." Rogers v. Westerman Farm Co., supra, 29 P.3d at 904 (quoting Owen L. Anderson, Royalty Valuation: Should Royalty Obligations Be Determined Intrinsically, Theoretically, or Realistically? (Part 2), 37 Nat. Resources J. 611, 637 (Summer 1997)).

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