Freeland v. Sun Oil Company, 17805.

• Decision Date: 21 April 1960
• Docket Number: No. 17805.,17805.
• Citation: 277 F.2d 154
• Parties: Barton W. FREELAND et al., Appellants, v. SUN OIL COMPANY and Cities Service Oil Company; Sohio Petroleum Company, Intervenor, Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

277 F.2d 154 (1960)

Barton W. FREELAND et al., Appellants, v. SUN OIL COMPANY and Cities Service Oil Company; Sohio Petroleum Company, Intervenor, Appellees.

No. 17805.

United States Court of Appeals Fifth Circuit.

March 24, 1960.

Rehearing Denied April 21, 1960.

Victor A. Sachse, Breazeale, Sachse, Wilson & Hebert, Baton Rouge, La., for plaintiffs-appellants.

Austin W. Lewis, Cullen R. Liskow, Lake Charles, La., for defendants-appellees and intervenor-defendant-appellee. Liskow & Lewis, Lake Charles, La., of counsel.

Before JONES, BROWN and WISDOM, Circuit Judges.

JOHN R. BROWN, Circuit Judge.

The basic question is whether a Louisiana mineral lessor's 1/8 gas royalty is to be based on 100% of the liquids extracted by an independent gasoline processing plant or on only that portion deliverable to the mineral interest owners after the processor has taken its share. Stated more simply, is the lessor to bear any part of the cost of processing? For if the basis is 100%, the result is that the lessor bears none of the costs. If the basis is the quantity remaining after the processor has taken its share, the lessor bears his proportionate part (e. g., 1/8) of the processor's share.

The District Court, on summary judgment, held that under the leases involved, the lessor must bear his prorata cost of processing. On the controverted issue reserved for trial, the Court, after trial, held that the processing costs chargeable under the processing agreement were not shown to be unreasonable. It therefore held in favor of the lessee-oil companies and against the lessor-royalty owners. We agree as to both actions.

As the primary question is one of law turning on the application of the lease contracts, the facts may be severely compressed. To secure maximum recovery of the minerals in the Egan Field of Acadia Parish, Louisiana, the Louisiana Conservation Commission pursuant to statutory authority ordered a unitization of large numbers of separate tracts and leases. This required the installation and maintenance of a recycling operation. In recycling, the gas flowing through the wellhead is first stripped of recoverable liquids. The dry gas remaining, quite appropriately called "residue gas" is used in two ways. A part may be sold and delivered to gas transmission concerns for resale as fuel to domestic or industrial users. The other portion, in the quantities and methods prescribed by conservation authorities, is then subjected to high pressure in the compressor plant and thereafter reinjected into the earth for repressurizing of the natural reservoir.¹ This recycling has to do with production of both gas and oil. It is a cost of production and the lessees have borne this without any attempted apportionment to the lessors.

We are not here concerned with royalty on the residue gas. That portion returned to the reservoir appears to be royalty-free under the lease.² On that portion sold, full royalties have been paid. What we are concerned with is the products obtained by the extraction process. This related to that step we briefly characterized above as gas being "stripped of recoverable fluids." These products comprise the heavier hydrocarbons reduced to a liquid state.

The liquid content of the gas is not separated on the leased premises. On the contrary, it is carried with other full stream gas to the processing plant. At the processing plant, the gas first goes through an inlet separator which removes the condensate from the full stream gas. As there are still heavier hydrocarbons remaining, the gas flowing out of the separator is sent to absorption towers where additional liquids are absorbed out. The residue gas is then sent through a dehydrator and is delivered to the pipe line company or returned to the recycling plant for reinjection into the reservoir. The liquids recovered from the inlet separator and absorption tower steps are then further processed through the fractionator to obtain propanes, butanes, motor fuel, and other products.

The processing plant is not owned or operated by either the lessor or lessees. It is owned by the Acadia Corporation, a corporation owned by an enterprise having extensive experience and technical competence in gas plants. The plant is an expensive and substantial industrial installation. It cost approximately $1,800,000. It was built by Acadia to handle the gas from this field after prolonged negotiations with the lessee-oil companies. Acadia, the processor, receives under the processing contract as compensation for building and operating the plant 35.7% of the end products. The balance, 64.3% is returned to the lessees. The lessee-oil companies have paid the 1/8 royalty on this 64.3%. What is at issue is the royalty on the 35.7% retained by Acadia, the processor.

We are not confronted with the question which plagues so many early cases, here and elsewhere, whether a lease covering gas and providing for payment of royalties for gas would encompass liquid products obtained from gas. Union Producing Co. v. Pardue, 5 Cir., 1941, 117 F.2d 225; O'Neal v. Union Producing Co., 5 Cir., 1946, 153 F.2d 157, certiorari denied, 329 U.S. 715, 67 S.Ct. 46, 91 L.Ed. 621; Arkansas Natural Gas Corp. v. Sartor, 5 Cir., 1938, 98 F.2d 527; see 3a Summers, Oil & Gas, §§ 595, 596 (1958) and § 596 (1959 Supp.). For the leases involved here expressly reserve royalties on gas in its gaseous state as well as gas used in the manufacture of gasoline and other products. The problem is not what is covered, i. e., conveyed by the grant. The problem is how is the royalty interest to be measured in the gas thus conveyed?

The answer must be found in the contracts which provided:

"The royalties to be paid by Lessee are: * * * (b) on gas, including casinghead gas or other gaseous substance, produced from said land and 1 sold or used off the premises or in the manufacture of gasoline or other products therefrom, the market value at the well of one-eighth of the gas so sold or used, provided that on 2 gas sold at the wells the royalty shall be one-eighth of the amount realized from such sale * * *."³

The lease, quite plainly, thus makes separate provision for two main situations: first, where the gas is 1 "sold or used off the premises"; and second, where it is 2 "gas sold at the wells." On the latter 2, the royalty is the specified fraction of the amount actually received. But where the gas is 1 sold or used off the premises, it is the "market value at the well" of gas so sold or used.

Here the record is uncontradicted that prior to the making of the processing contract with Acadia, the gas at the well-head had little marketability and hence no demonstrated market value. As gas had to be repressurized for reinjection into the reservoir, the gas operations, apart from increased oil recoveries, would be productive only to the extent that liquefiable components could be extracted in the course of the passage of the gas from wellhead through compressor and reinjection into the reservoir. In other words, if all of the gas and its components were restored to the reservoir, nothing of value would be obtained from the gas. To achieve recovery of liquid components with maximum efficiency, a modern, expensive gasoline extraction plant was essential. Quite obviously then the value of the raw, wet gas in its relatively unmarketable state at the wellhead was not equivalent to the price which the end product of that industrial process would command. The wet gas was important. Indeed, it was the indispensable raw material. But the availability of the extracting process and its application enhanced the value of the gas. The enhancement is of the value of the gas at the wellhead, not at a subsequent point, much as would be the case in the comparative availability of pipe line connections for ordinary gas.

In determining the market value of such gas at the well where there is no established criteria of a market, the Louisiana approach, which is binding on us, is to consider the end product of the extraction process as a factor. But it is a factor in reconstructing a market value at a place where in fact there was no, or little, market and consequently an appropriate deduction must be made.

The first case was Coyle v. Louisiana Gas & Fuel Co., 1932, 175 La. 990, 144 So. 737. After first holding that the lessor-royalty owner was entitled to royalty on 100% of the products of the extraction plant, the Court on rehearing held that the royalty should be computed on the basis of that portion of the end products which were returned by the processor under the processing contract.⁴ The Court proceeded from the point of view that where large expenditures make a valueless commodity one of great value, the contract would be harsh unless the costs were shared. Consequently, it was proper that the contract should be construed, if possible, to avoid that result. The Court then declared that "the law would step in, as a part of the contract" to say whether the royalty should be delivered free of costs. "This," the Court said, "we think the law has done by providing, in effect, that the cost of extraction, incurred by the lessee, to preserve the gas and its gasoline content, by making both merchantable, should be deducted before computing and delivering...