Matzen v. Hugoton Production Co.

• Decision Date: 14 February 1958
• Docket Number: No. 40745,40745
• Citation: 182 Kan. 456,321 P.2d 576,73 A.L.R.2d 1045
• Parties: , 73 A.L.R.2d 1045 Carl F. MATZEN and Mary S. Matzen, Appellees and Cross-Appellants, v. HUGOTON PRODUCTION COMPANY, a Corporation, Appellant and Cross-Appellee.
• Court: Kansas Supreme Court

Page 576

321 P.2d 576

182 Kan. 456, 73 A.L.R.2d 1045

Carl F. MATZEN and Mary S. Matzen, Appellees and Cross-Appellants, v. HUGOTON PRODUCTION COMPANY, a Corporation, Appellant and Cross-Appellee.

No. 40745.

Supreme Court of Kansas.

Feb. 14, 1958.

Rehearing Denied March 12, 1958.

Syllabus by the Court

1. In an action to recover the landowners' royalty from a well where gas only is produced under two oil and gas leases covering lands in the Hugoton Gas Field where the lessee agreed to pay the lessors as royalty 'one-eighth of the proceeds from the sale of the gas, as such, for gas from wells where gas only is found,' and the lessors concede royalty is determined at the wellhead and that they should pay reasonable expenses of gathering, processing and marketing the gas produced where it is transported by the lessee in its pipe-line gathering system off the premises and processed and sold, held: The lessee's royalty obligation is measured by a 'proceeds-less-expenses' formula, i. e., by deducting from gross proceeds reasonable expenses relating directly to the costs and charges of gathering, processing and marketing the gas produced and sold.

2. In determining royalty due the lessors at the wellhead, under circumstances described in p1, federal and state income taxes of the lessee resulting from profits arising from the sale of gas are not properly deductible as an expense of gathering, processing and marketing the gas produced.

3. The record in an action to recover the landowners' royalty from November 1, 1954, to April 30, 1955, examined and held: The trial court did not err (1) in applying the 'proceeds-less-expenses' formula to the lessee's accounting period for the calendar year of 1955 instead of to its monthly accounts for the period involved, and (2) in allowing the lessee the value of gas used as fuel and shrinkage which occurred in processing the gas for market since it was an expense properly allowable under the formula.

Mark H. Adams, Wichita, and G. R. Redding, Indianapolis, Ind., argued the cause, and Ray H. Calihan, Logan N. Green, Daniel R. Hopkins and Ray H. Calihan, Jr., Garden City, Samuel H. Riggs, Liberal, Charles E. Jones, William I. Robinson, J. Ashford Manka, Clifford L. Malone, Mark H. Adams, II, and John S. Seeber, Wichita, were with them on the briefs, for appellant and cross-appellee.

Wayne Coulson, Wichita, argued the cause, and A. E. Kramer and Bernard E. Nordling, Hugoton, and Homer V. Gooing, Paul R. Kitch, Dale M. Stucky, Donald R. Newkirk, Robert J. Hill, Gerrit H. Wormhoudt, Theodore C. Geisert and Philip Kassebaum, Wichita, were with him on the briefs, for appellees and cross-appellants.

FATZER, Justice.

This was an action to recover the landowners' royalty from November 1, 1954, to April 30, 1955, under a producing oil and gas lease in the Hugoton Gas Field (field). The principal question presented is the amount to be paid to plaintiff lessors as royalty under the terms of the leases in effect between them and the defendant Hugoton Production Company (Hugoton) as lessee operator. A jury was waived and trial had by the court. Judgment was in favor of plaintiffs, and Hugoton has appealed from the order overruling its motion for a new trial. Plaintiffs have cross-appealed from adverse rulings and orders of the trial court.

The trial court made extensive findings of fact and conclusions of law, pertinent portions of which are summarized: Plaintiffs are the owners of 320 acres in the field in Grant County, Kansas. In 1941 Panhandle Eastern Pipe Line Company (Panhandle) acquired oil and gas leases covering a block of approximately 95,000 acres (block) in the field among which were two leases covering plaintiffs' half section and later included in a 640-acre unitization agreement on which Hugoton now owns and operates one producing gas well. The royalty clause in each of the leases covering plaintiffs' land read, in pertinent part, as follows:

'The lessee shall pay lessor, as royalty, one-eighth of the proceeds from the sale of the gas, as such, for gas from wells where gas only is found. * * *'

Pursuant to the two leases on plaintiffs' land and the unitization agreement plaintiffs were entitled as royalty to one-sixteenth of the proceeds from the sale of gas produced from the well on the unit of which their leases were a part.

The discovery well in the field was drilled approximately 30 years ago and by continuous development the field was ascertained to be approximately 90 miles north and south and 60 miles east and west, containing roughly three million acres, with an estimated original gas reserve of thirteen trillion cubic feet. In October 1948 there were approximately 1100 producing natural gas wells and the prevailing price for the gas in the field was approximately five and one-half cents per M. c. f. based on 16.4 pounds p. s. i. a. In order that the gas might be profitably sold, it was necessary that it be transported from the wellheads to distant densely populated areas since the supply greatly exceeded the demand in the field.

In an effort to place its block of leases into production and to secure a higher price for the gas to be produced, Panhandle entered into negotiations with the Kansas Power and Light Company (power company) for the sale of gas, which resulted in the organization of Hugoton in September, 1948, for the purpose of acquiring and developing the block, and constructing necessary facilities to gather, transport, process and deliver gas to the power company.

Following Hugoton's incorporation, Panhandle assigned its undeveloped block of leases to Hugoton, which entered into a contract with the power company on October 18, 1948, to supply gas for a fifteen-year period, reserving its entire production from the block to fulfill minimum delivery commitments at a base price of $0.12 per M. c. f. for processed gas for resale, and at a base price of $0.15 a million b. t. u. for gas used by the power company to operate its power plants. Provision was made for price adjustments at five-year intervals, which resulted on November 1, 1954, in an increase of 3.65 cents per M. c. f., or a delivery price of 15.65 cents per M. c. f. for processed gas for resale, measured at 14.9 pounds. However, due to an unresolved dispute between the parties, the power company has paid Hugoton only 15.58 cents per M. c. f.

To obtain the production of gas and to comply with its contractual obligations, Hugoton promptly commenced development of the block and now has 152 producing gas wells. It constructed a gathering pipe-line system of steel pipe ranging from 4 to 24 inches in diameter having a total length of over 184 miles, which connected each gas well, including the plaintiffs' well, so as to permit the natural gas produced to be metered at the wellhead and flow in a comingled mass to a point in the block for sale to the power company and delivery to its pipe line. Hugoton also constructed a gasoline plant for the extraction of liquid hydrocarbons and a dehydrating plant through which all the gas passed in a continuous and uninterrupted movement for delivery to the power company where liquid fuel by-products, viz., natural gasoline, butane and propane were extracted and processed by Hugoton after which the residue or 'dry' gas was sold to the power company and delivered to its pipe line. The dehydration plant was operated on the outlet side of the gasoline plant and the power company paid Hugoton for dehydration of the gas at the rate of $.0015 cents per M. c. f. Hugoton sells all liquid fuel by-products to Warren Petroleum Company (Warren).

On October 11, 1953, Hugoton entered into a contract with Columbian Carbon Company (Columbian) whereby it agreed to sell certain quantities of raw natural gas as might be available after its contractual obligations to the power company had been fulfilled. The price agreed upon was 13.4 cents per M. c. f. measured at 14.65 pounds, and delivery was to be made at a point distant from the wellheads, unprocessed. Except for such gas as was used in its plant operations, or unavoidably lost, the gas produced by Hugoton from the block was delivered to the power company as processed gas for resale; to Columbian as raw natural gas; or, to Warren in the form of liquid hydrocarbons.

Hugoton made royalty payments to plaintiffs at the rate of $0.11 per M. c. f. based upon the minimum wellhead price order of the State Corporation Commission effective January 1, 1954 (docket No. 44,079-C[C-3216]), which, under it authority to prevent waste and conserve natural gas, fixed a minimum wellhead price as a condition precedent for withdrawal of the gas from the field of not less than $0.11 per M. c. f. measured at 14.65 pounds, the validity of which was sustained by this court in Cities Service Gas Co. v. State Corporation Commission, 180 Kan. 454, 304 P.2d 528, reversed 355 U.S. 391, 78 S.Ct. 381, 2 L.Ed.2d 355.

No dispute exists as to the amount of gas produced. Both parties here assert that Hugoton's royalty obligation is to be determined at the wellhead rather than at the point of sale and delivery off the lease, and further, that there is no market price at the wellhead for the gas taken by Hugoton. Thus, a known amount of gas is produced and sold by Hugoton under contracts calling for a definite price; hence, there remains but one element necessary to determine proceeds at the wellhead, i. e., the price to be paid for the gas at that point. The amount due the plaintiffs as royalty is then only a matter of calculation.

The trial court found, among other things, that at the time the leases covering plaintiffs' land were executed it was the established practice and custom in the gas production industry to measure, determine the price, and pay gas royalty at the wellhead on all gas produced in the field upon a pressure basis of 16.4 pounds, which was later changed by the State Corporation Commission to a pressure basis of 14.65 pounds,...