Garman v. Conoco, Inc., 94SA191

• Decision Date: 05 December 1994
• Docket Number: No. 94SA191,94SA191
• Citation: 886 P.2d 652
• Parties: 132 Oil & Gas Rep. 488, Util. L. Rep. P 26,439 James P. GARMAN, Robert D. Garman, and Mark Bruce Garman, Plaintiffs, v. CONOCO, INC., Defendant.
• Court: Colorado Supreme Court

Page 652

886 P.2d 652

132 Oil & Gas Rep. 488, Util. L. Rep. P 26,439

James P. GARMAN, Robert D. Garman, and Mark Bruce Garman, Plaintiffs, v. CONOCO, INC., Defendant.

No. 94SA191.

Supreme Court of Colorado En Banc.

Dec. 5, 1994.

Dufford, Waldeck, Milburn & Krohn, William H.T. Frey, Flint B. Ogle, Grand Junction, for plaintiffs.

Davis, Graham & Stubbs, Charles L. Kaiser, Clyde O. Martz, Anthony J. Shaheen, Denver, for defendant.

Robin Stead & Associates, P.C., Robin Stead, Donald F. Heath, Jr., Norman, OK, amicus curiae for Nat. Ass'n of Royalty Owners.

Bjork, Seavy, Lindley & Danielson, P.C., Laura Lindley, Denver, amicus curiae for Rocky Mountain Oil and Gas Ass'n.

McDaniel, Baty & Miller, G.R. Miller, Durango, amici curiae for Richard Parry, Linda Parry, Petrogulf Corp., a Colorado corp., Douglas Cameron McLeod, Evelyn L. Payne, David G. Groblebe, Elizabeth A. Groblebe, RDG, Inc., a Colorado corp., and Harry E. Fassett, Lavaun Wilde and Jack W. Fassett, as Trustees of the Fassett Family Trust.

Chief Justice ROVIRA delivered the Opinion of the Court.

The following question of law was certified to this court by the United States District Court for the District of Colorado in accordance with C.A.R. 21.1:

Under Colorado law, is the owner of an overriding royalty interest in gas production required to bear a proportionate share of post-production costs, such as processing, transportation, and compression, when the assignment creating the overriding royalty interest is silent as to how post-production costs are to be borne?

The district court provided three examples of post-production costs but left the term "post-production costs" undefined. We recognize that each of the activities posited in the certified question occurs throughout the gas production process. Gas may require processing to remove impurities for marketing and once marketable may be further processed into additional component products. Transportation is required when gas is moved from the wellhead to a central location to prepare it for transmission and consumption, commonly referred to as gathering. See John C. Jacobs, Problems Incident to the Marketing of Gas, 5 Inst. on Oil & Gas L. & Tax'n 271, 273 (1954). If no market for the gas exists near the wellhead, transportation may be required to move the gas to a distant market. ¹ Compression may be required to create sufficient pressure for the gas to enter a purchaser's pipeline, ² or compression may occur to transform the gas into additional products. ³ The parties understand the nature of the gas production, and agree that there exists a point in the production process when an overriding royalty owner may become obligated to bear a proportionate share of costs. They do not agree when proportionate allocation should occur. Because we cannot anticipate every conceivable type of post-production cost, and whether it occurs before or after a marketable product is obtained, we consider the certified question as if it were posed without the examples.

In addition, our consideration of the certified question is based on our understanding that "the assignment creating the overriding royalty interest" is indeed silent with respect to the allocation of post-production costs. The district court posed the certified question in general terms, and we answer to provide guidance when an assignment does not address the allocation of post-production costs. Had the district court wanted this court to consider the assignment from the Garmans to Lee A. Adams, who eventually assigned the leases to Conoco, we believe the question would have been framed to elicit a more specific response. However, the briefs submitted by the parties and amici curiae focused on the general principles of oil and gas law relating to the allocation of post-production costs. Other than a limited request by the Garmans to consider the language of the assignment in this case, they also assumed that the "response to the question should be a statement of the general principles of Colorado law applicable to the issue." While the Garmans asked us to "address the application of the legal principles announced to the undisputed facts of this case" we decline to do so. ⁴ We believe we can respond appropriately to the district court on the law in Colorado without considering the specific assignment terms.

With this background in mind, limiting our response to those post-production costs undertaken to convert raw gas into a marketable product, and relying on the basic proposition that every oil and gas lease contains an implied covenant to market, we answer the certified question in the negative. We now turn to the facts which provide a foundation for the certified question and our answer.

I

During the years 1951 through 1953, M.B. and B.K. Garman acquired eight federal oil and gas leases covering approximately 10,742 acres situated in Rio Blanco County, Colorado (the Leases). Through a series of assignments the Leases were transferred to Conoco, Inc. (Conoco) subject to a reserved 4.00% overriding royalty interest now owned in equal shares by James P. Garman, Robert D. Garman and Mark Bruce Garman (collectively Garmans). ⁵

The Leases are located in Dragon Trail Unit (Unit) and continue in full force and effect by the production of gas. Conoco operates both the Unit and the Dragon Trail Processing Plant (Plant). ⁶ The Plant is located outside of both the Lease and the Unit boundaries. From the wellhead, gas enters a gathering line for transportation to the Plant. At the Plant, gas from the Unit is processed into three separate products: (1) residue gas; (2) propane; and (3) a combined stream of butane and natural gasoline (the "butane-gasoline stream"). The gross proceeds from the sale of the individual products are greater than the revenues which would have been obtained from the sale of the raw, unprocessed gas at the wellhead. Plant operations are typical of processing operations performed to enhance the value of gas. The parties have not stipulated as to the reasonableness of the processing costs.

Historically, Conoco has deducted the cost of certain post-production operations from the overriding royalty payments due to the Garmans. ⁷ From January, 1987 until April, 1993, the Garmans' proportionate share of post-production costs was $459,511 on overriding royalty payments totaling approximately $2.2 million. In 1993, the Garmans filed an action in federal court requesting declaratory relief to determine the parties' rights under the original 1956 assignment creating the overriding royalty interest, and an accounting to determine whether post-production charges for the previous six years were properly assessed against their overriding royalty interest.

The Garmans argue post-production costs incurred to convert raw gas into a marketable product should not be charged against nonworking interest owners. Accordingly, they object to Conoco's deduction of the costs necessary to make gas from the Leases marketable. The Garmans concede that costs incurred after the gas is made marketable, which actually enhance the value of the gas, should be borne proportionately by all parties benefitted by the operations. ⁸ They argue, however, that no evidence exists to show Conoco's operations increase the actual royalty amount paid to the Garmans. Finally, they argue under the doctrine of expressio unius est exclusio alterius that the assignment creating their overriding royalty prohibits Conoco from assessing post-production costs against their royalty. ⁹

Conoco argues that all post-production costs incurred after gas is severed from the ground and reduced to possession should be borne proportionately by royalty, overriding royalty and working interest owners. Conoco asserts severance occurs at the wellhead and that all expenses incurred after severance improve or enhance the value of the gas from its natural, unprocessed state. Thus, it claims that royalty and overriding royalty interest owners who benefit from these operations ought to share in the cost of all post-production operations.

II

A

"The fundamental purpose of an oil and gas lease is to provide for the exploration, development, production and operation of the property for the mutual benefit of the lessor and lessee." Davis v. Cramer, 808 P.2d 358, 360 (Colo.1991). The lessor relinquishes its right to the mineral estate in exchange for a smaller non-risk and non-cost bearing royalty interest ¹⁰ in any minerals discovered. See Wood v. TXO Production Co., 854 P.2d 880, 882-83 (Okla.1992) ("The lessor, who generally owns the minerals, grants an oil and gas lease, retaining a smaller interest, in exchange for the risk-bearing working interest receiving the larger share of the proceeds....."). Similar to a royalty, an overriding royalty is an interest in oil and gas produced at the surface, free of expense of production, generally assessed in addition to the usual mineral owner's royalty. See, e.g., 8 Williams & Meyers at 859; see also Hagood v. Heckers, 182 Colo. 337, 347, 513 P.2d 208, 214 (1973). While the lease agreement creates the royalty obligation, overriding royalty interests are typically reserved or created by separate agreement. ¹¹ See 2 Williams & Meyers § 418. Though their contractual origins may differ, both royalty and overriding royalty interests are non-risk and non-cost bearing interests. See id. § 418.1 ("An overriding royalty is, first and foremost, a royalty interest.... it is an interest in oil and gas produced at the surface free of the expense of production."). Naturally, the contracting parties are free to allocate the costs of compression, transportation and processing in their agreements. E.g., Magnetic Copy Serv. v. Seismic Specialist, Inc., 805 P.2d 1161, 1163 (Colo.App.1990). Often, however, these agreements fail to apportion expenses that may be incurred after the discovery of oil or gas. ¹²

Though a lease is entered into for the mutual benefit of ...