Mittelstaedt v. Santa Fe Minerals, Inc.

• Decision Date: 20 January 1998
• Docket Number: No. 84977,84977
• Citation: Mittelstaedt v. Santa Fe Minerals, Inc., 954 P.2d 1203, 1998 OK 7 (Okla. 1998)
• Parties: Ted MITTELSTAEDT, an individual, Ruth Mittelstaedt, an individual, Plaintiffs-Appellees, v. SANTA FE MINERALS, INC., a corporation, Defendant-Appellant.
• Court: Oklahoma Supreme Court

Page 1203

954 P.2d 1203

1998 OK 7

Ted MITTELSTAEDT, an individual, Ruth Mittelstaedt, an individual, Plaintiffs-Appellees, v. SANTA FE MINERALS, INC., a corporation, Defendant-Appellant.

No. 84977.

Supreme Court of Oklahoma.

Jan. 20, 1998.

Dissenting Opinion by Justice Opala

Modified March 5, 1998.

Gregory A. McKenzie, William K. Elias, Michael J. Massad, and Frank H. McGregor of McKenzie, Moffett, Elias & Books, Oklahoma City, for Plaintiffs-Appellees.

Gary W. Davis, Mark D. Christiansen, and Paul D. Trimble of Crowe & Dunlevy, Oklahoma City, and William H. Boyles, Santa Fe Minerals, Inc., Dallas, TX, for Defendant-Appellant.

Robin Stead, Donald F. Heath, Jr., Heath, P.C., for Amicus Curiae National Association of Royalty Owners, Norman, Oklahoma.

Brenton B. Moore, Oklahoma Mid-Continent Oil & Gas Association, James C.T. Hardwick of Hall, Estill, Hardwick, Gable, Golden & Nelson, P.C., Tulsa, Joseph W. Morris, Teresa B. Adwan, M. Benjamin Singletary of Gable & Gotwals, Inc., for Amicus Curiae for Oklahoma Mid-Continent Oil and Gas Association, Tulsa, Oklahoma.

SUMMERS, Vice Chief Justice.

¶1 Gas well lessors filed suit in Federal Court, claiming they were not getting the full "3/16 of the gross proceeds received for the gas sold" as called for in the lease. Lessee in response explained it was deducting the lessor's share of post-production expenses in marketing the gas, and then remitting 3/16 of the proceeds as royalty. The trial court entered judgment in favor of the lessors for their portion of the proceeds deducted and withheld by the lessee, plus interest. The case is now in the Tenth Circuit Court of Appeals. Since the case will turn on Oklahoma law the Circuit Court has certified the question to us, framed as follows:

In light of the facts as detailed below, is an oil and gas lessee who is obligated to pay "3/16 of the gross proceeds received for the gas sold" entitled to deduct a proportional share of transportation, compression, dehydration, and blending costs from the royalty interest paid to the lessor?

¶2 We conclude that this clause, when considered by itself, prohibits a lessee from deducting a proportionate share of transportation, compression, dehydration, and blending costs when such costs are associated with creating a marketable product. However, we conclude that the lessor must bear a proportionate share of such costs if the lessee can show (1) that the costs enhanced the value of an already marketable product, (2) that such costs are reasonable, and (3) that actual royalty revenues increased in proportion with the costs assessed against the nonworking interest. Thus, in some cases a royalty interest may be burdened with post-production costs, and in other cases it may not. ¹

¶3 The two wells are in Canadian County. Some compression operations and associated expenses were performed at the wellhead. Lessee Santa Fe Minerals, Inc. did not charge the royalty interests with these costs. But then the gas was moved downstream to a location off the leased premises, where Santa Fe paid unaffiliated third parties for transportation fees, blending fees, dehydration fees, and compression fees. ² Santa Fe charged a proportion of these costs against the royalty interests. The gas was then moved further downstream where it was placed into the purchaser's pipeline. The Mittlestaedts went to court to recover that portion of the latter costs charged against their royalty as lessors. The trial court, in one of its rulings, recognized as an undisputed fact that the expenses in controversy incurred by Santa Fe "were incurred for the purpose of improving the quality of the gas produced from the wells involved, thereby resulting in a higher price being received from the purchaser and to permit sale at better, higher-priced markets."

¶4 Our assignment requires us, at the outset, to analyze these Oklahoma cases: Wood v. TXO Production Corp., 1992 OK 100, 854 P.2d 880, TXO Production Corp. v. State ex rel. Commissioners of the Land Office, 1994 OK 131, 903 P.2d 259, (because Wood and this second case both involve TXO we will refer to it as CLO ), and Johnson v. Jernigan, 475 P.2d 396 (Okla.1970).

¶5 In Wood we rejected the idea that compression costs to "enhance" (or make marketable) a product should be shared by the royalty interest. Wood, 854 P.2d at 881. However, we also said in Wood that "in Oklahoma the lessee's duty to market involves obtaining a marketable product." In our case the royalty owners rely upon the first above quote. The lessee relies upon the latter, arguing that its duty is fulfilled by delivering a marketable product at the leased premises, and that costs incurred after the this duty is fulfilled may be allocated proportionately to the royalty interest. It is noteworthy that in Wood the compression took place on the leased premises.

¶6 In CLO the lessee wanted to charge compression and dehydration costs to the lessors. Our Court said no, these operations were required to make the gas marketable, as required by the Lessees's implied covenant to market. The enhancement operations in CLO, as in Wood, took place at the wellhead, on the leased premises.

¶7 In Johnson v. Jernigan, the lessee wanted to charge the lessor its proportionate share of transportation costs to the nearest market. We allowed that to happen because there was no market available for the gas at the lease. The lessee's duty to market did not include bearing the full burden of delivery to an off-site purchaser.

¶8 In all these opinions the Court had to fix the rights and duties of the parties according to the language of the leases and the implied covenants that go with them. The clause immediately preceding the "gross proceeds" clause in our case is an in kind clause requiring the lessee "To deliver to the credit of lessor free of cost, in the pipe line to which it may connect its wells, the 3/16 part of all oil...." ³ In CLO we stated that the lease phrase "without cost into pipelines" modifying an "in kind" clause also referred to lessee's 1/8 payment of the market value of the gas sold to the lessor. Id. 903 P.2d at 261. We then concluded that the 1/8 market value paid to the lessor did not bear any of the lessee's costs from processes necessary to get the product into the pipelines. Id. Unlike the present case, in CLO delivery to the purchaser's pipeline occurred at the leased premises.

¶9 In CLO we examined the language of the lease. Id. 903 P.2d at 260-261. We use the plain meaning of the terms when doing so. Trawick v. Castleberry, 275 P.2d 292, 294 (Okla.1953). Using the plain meaning of the phrase "gross proceeds" suggests that the payment to the lessor is without deductions. See Pioneer Telephone Co-op. Inc. v. Oklahoma Tax Commission, 1992 OK 77, 832 P.2d 848, where we defined "gross receipts" for the purpose of sales taxes and used its plain meaning. This view of gross receipts has also been used when interpreting a royalty clause: "The term 'gross proceeds' usually implies no deductions of any kind." Altman and Lindberg, Oil and Gas: Non-Operating Oil and Gas Interests' Liability for Post-Production Costs and Expenses, 25 Okla.Law Rev. 363, 375 (1972), [citing, Brown, Royalty Clauses in Oil and Gas Leases, 16 Oil & Gas Inst. 161 (SW. Legal Found.1965) ]. Consistent with this approach, we have explained that when the lease requires payment of the "market value" of the gas this value "means the gas purchase contract price." Helmerich & Payne, Inc. v. State ex rel. Commissioners of the Land Office, 1997 OK 30, p 12, 935 P.2d 1179, 1181. But when certain circumstances are present this definition of "gross receipts," as being a value with no deductions, has been tied to the value of the product at a certain location, that is, the leased premises, or wellhead.

¶10 In Johnson v. Jernigan, 475 P.2d 396 (Okla.1970) we explained that gross proceeds "has reference to the value of the gas on the lease property without deducting any of the expenses involved in developing and marketing the dry gas to this point of delivery." Id. 475 P.2d at 399. Thus, "gross proceeds" does indicate an amount without deduction from, or charge against, the royalty interest, but only when the point of sale occurs at the leased premises.

¶11 The third clause discussed by the parties provides that the lessee will "pay lessor for gas produced from any oil well and used off the premises, or for the manufacture of casing-head gasoline or dry commercial gas, 3/16 of the gross proceeds, at the mouth of the well, received by lessee for the gas...." A producer has a duty to market gas from a producing well. Tara Petroleum Corp. v. Hughey, 1981 OK 65, 630 P.2d 1269, 1273. The parties argue whether this clause means that the lessee's duty to market is measured by the performance of the lessee at the wellhead. This contention requires discussion of a lessee's implied covenant to market.

¶12 In CLO we first analyzed the lessee's duties as specified by the lease. After we concluded that the lessor did not pay certain post-production costs because of the language of the lease, we then explained that the result in that case was consistent with our opinion in Wood, discussing a lessee's implied covenant to market gas. Id. 903 P.2d at 261. We said that the lessee must make the gas available to market at the leased premises (wellhead). Making the gas available to market at the leased premises means that the lessee must produce the gas in a marketable form at the leased premises. Thus, when discussing a lessee's duty to provide a marketable product at the leased premises we said that "the implied duty to market means a duty to get the product to the place of sale in marketable form. Here [in both Wood and CLO] the compressors ... are on the leased premises." (quoting Wood, emphasis deleted) Id. 903 P.2d at 262.

¶13 The Mittelstaedts argue that when the sale is at a distant market the implied duty of the lessee under the lease is to pay for...