Butler v. Exxon Corporation

559 S.W.2d 410, 59 Oil & Gas Rep. 529, 1977 Tex. App. LEXIS 3563

• Court: Court of Appeals of Texas
• Decided: November 16, 1977
• Docket: 6644
• Status: Published

Opinions

OPINION

OSBORN, Justice.

This case involves the question of whether or not additional royalties are due to the lessors under gas royalty provisions of four oil and gas leases which were executed in 1966. The trial Court denied any additional recovery. We affirm in part and in part reverse and remand.

The basic dispute results from the fact that the price of natural gas in the intrastate market in Texas rapidly escalated from the time the gas discovered under these leases was sold for less than 20<p per mcf in 1970 to over $2.00 per mcf by early 1975. Relying primarily upon Texas Oil & Gas Corporation v. Vela, 429 S.W.2d 866 (Tex.1968), Appellants contend that they should have been paid a gas royalty based on market value when the gas was delivered to the purchaser. See: Kelly, “What Price, Gas?”, 7 St. Mary’s L.J. 333 (1975).

The four leases cover lands which form a part of the Atkinson Gas Field in Karnes and Live Oak Counties. In 1970, after the first wells were drilled, the lessee executed contracts to sell the gas for the next twenty years. On the gas produced from Units Nos. 2 and 4, the initial price was 18$ per mcf. On Unit No. 5, the price was 18V2$. In addition, another 1½$ per mcf was paid for processing rights for the extraction of liquid hydrocarbons. Each of the gas contracts had a provision for a price escalation of 1$ per mcf every five years. From the beginning of production in 1970 until it assigned the leases to a third party on October 1, 1975, Exxon made royalty payments to the lessors based upon the amount realized from such sales.

The two principal leases, being Exxon Leases Nos. 510294 and 510296 which cover nearly 80% of the Butler acreage involved in this suit, contained the following royalty clause:

“The royalties to be paid by Lessee are: (a) on oil, one-eighth of that produced and saved from said land, the same to be delivered at the wells or to the credit of Lessor into the pipe line to which the wells may be connected; Lessee may from time to time purchase any royalty oil in its possession, paying the market price therefor prevailing for the field where produced on the date of purchase; (b) on gas, including casinghead gas or other gaseous substance, produced from said land and sold or used off the premises or for the extraction of gasoline or other product therefrom, the market value at the well of one-eighth of the gas so sold or used, provided that on gas sold at the wells the royalty shall be one-eighth of the amount realized from such sale; * * * and (c) on all other minerals mined and marketed, Vs either in kind or value at the well or mine * *

Lease No. 510292 contains a very similar clause except for a provision for payment to two different royalty owners, the lessors and the State. See: Gregg, “Analysis of the Usual Oil and Gas Lease Provisions”, 5 S.Tex.L.J. 1 at 13 (1960).

Lease No. 510266, which covers 26.11 acres and 3.2% of the Butler acreage involved in this suit, contains a clause which requires the lessee to pay to the Veterans’ Land Board and to deliver to the credit of the lessor “one-sixteenth of the market value at the well of all gas produced and saved from the leased premises.”

After gas was discovered in the Atkinson Field, parts of these leases were unitized pursuant to Railroad Commission Regulations to form parts of three one-well units. Following production, the Butlers executed a series of division orders which provided:

“Settlements for gas sold at wells or at a central point in or near the field where produced shall be based on the net proceeds at the wells. * * * ”

After Hattie L. Butler, Appellant’s mother, died in September, 1973, a new division order, dated November 1, 1973, was executed which provided for settlements on oil and gas to be in accordance with the royalty provisions of the leases. The original division orders were revoked on April 1, 1975, and a new division order was signed to require payments for oil and gas in accordance with the royalty provisions in the leases.

Much of the testimony in the case consists of opinion evidence of expert witnesses. Each side used a consulting petroleum engineer to develop their theory of the case. Mr. Max Powell, testifying as an expert witness for the Appellants, commenced with a tabulation of gas sales in a seven-county area of South Texas, and ultimately reached a conclusion as to the market value of gas in the Atkinson Field for each quarter from October, 1972, until October, 1975. These prices ranged from 32.9<t per mcf at the beginning to $2.06 per mcf at the end. Basically, he averaged the top three sales in Live Oak and Karnes Counties each quarter to determine market value during such period. He said all sales which he finally used were comparable in quantity, quality, and availability of gas. He concluded that the Butlers had been underpaid in the amount of $187,881.55, plus interest of $27,407.29. He readily admitted that this determination was based on new gas coming into the market under current market conditions. Mr. Powell testified, and the trial Court found, that the gas was delivered to the purchaser at the tailgate of a centralized separation, dehydration, and compressing facility of Exxon which was located approximately 100 feet west of the west fence line on the Butler property and thus was off the leased premises. Mr. Powell concluded that there could be a sale at the well even though delivery was made to the purchaser several hundred feet from the well head. But he said a sale off the premises, as in this case, was not in his opinion a sale at the well. In this regard, he said:

“ * * * that the circumstance in which Exxon obligated itself to pay royalty to the Butler families called for market value at the well for gas sold or used off of the premises, and that is what happens here. You are not selling the gas on these premises. The delivery point is off of the premises and that is what invokes, in my view, the market value clause.

‡ * * ‡ * *

“ * * * It cannot be construed as a sale at the well for the three units for which the Butler family owns royalty because the delivery point and the point of sale is not located on any of those three units.

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“I’m saying to you that if the sale had taken place on the premises covered in the lease, then it would have been a proceeds royalty provision and not a market value provision.”

Mr. H. J. Gruy testified as an expert witness for the Appellee and said that in his opinion Exxon was required to execute long term contracts to sell the gas in 1970, and that in his opinion they got fair market value and the best price available at the time of sale. He said sales after 1970 were not comparable and could not be considered in determining market value. Mr. Gruy considered the sale by Exxon to be at the well. He testified:

Q Normally what would you consider to be a well head sale?

“A Well, a well head sale is generally considered to be a sale in or near the wells as distinguished from tailgate of a plant sale.

“Q Okay. If you had a sale, say, that occurred at the tailgate of a, say, a compression station located off of the lease premises over on another lease, would you consider that as a well head sale?

“A I would.”

The trial Court filed extensive Findings of Fact and Conclusions of Law. In addition to the undisputed facts set forth above concerning the leases and gas contracts, the Court found that in 1970 a prudent operator would make every reasonable effort to market the gas from Units Nos. 2, 4, and 5 as quickly as possible so as to prevent drainage from other wells in the field. The Court also found that in 1970 gas could only be sold on long term contracts with minimal price escalation provisions, and that the contracts for this gas were bona fide arms length transactions with a price as good or better than any prices being paid for gas in Karnes and Live Oak Counties at that time. The Court also found that Exxon had attempted diligently but unsuccessfully to renegotiate the contracts.

With regard to payments called for by the lease provisions and those actually made, the Court found:

“9. This Court finds that the gathering, compression and dehydration expenses incurred by Exxon and charged against the contract prices in the royalty computations were ordinary and reasonable.

“10. At all times material to this case, and specifically commencing with the last quarter of 1972, down through and including the third quarter of 1975, the defendant Exxon Corporation paid royalties to plaintiffs on the gas produced from the land covered by the above mentioned leases on the market value at the well of Vsth of the gas sold.

“11. The market value at the well of the gas which was sold was the total proceeds received by the defendant Exxon Corporation from Lo-Vaca Gathering Company and Coastal States, less the cost of gathering, compressing and dehydration which were required to make the gas marketable. The Court specifically finds that the market value at the well of the gas produced from Unit 2 was 19½ cents per met [sic] at all times material to this case, and specifically commencing with the last quarter of 1972 through the third quarter of 1975, less the expenses of gathering, compression and dehydration shown in Column 5 of Plaintiffs’ Exhibit 17 for each month during that period of time when there was gas production, and the Court finds that the market value at the well of the gas produced from Unit 4 was 19½ cents per mef through May 1975, and 20½ cents per mef thereafter, less the expenses of gathering, compression and dehydration shown in Column 5 of Plaintiffs’ Exhibit 17 for each month during that period of time when there was gas production, and the Court finds that the market value at the well of the gas production from Gas Unit 5 was 20 cents per mef during that period of time, less the cost of gathering, compression and dehydration which was shown in Column 5 of Plaintiffs’^Exhibit 17 as to that gas unit.

“12. While the Court finds that the defendant has paid the plaintiffs royalties on the gas produced and sold from their leases on the basis of the market value at the well, without regard to whether the gas is sold at the wells, the Court further finds that the sale of gas from these leases was a sale ‘at the wells’ within the meaning of those terms in the leases. It is so understood in the industry. Specifically, this Court finds that the term ‘at the wells’ means gas delivery which occurs in the vicinity of the field of production where the wells are located, rather than at some remote location such as the other end of a gas transmission line.. For a sale to be termed ‘at the wells’, delivery need not occur at the ‘Christmas tree’ on top of the well casing, nor is there any requirement that delivery occur on the particular lease or unit from which the gas is produced. Any such distinction would be artificial and have no relation to the prudent and economican [sic] operation of a gas field. Therefore, the Court finds that the plaintiffs have also been paid royalties on gas produced and sold at the wells on Vbth of the amount realized from such sale, the amount realized from such sale constituting the total proceeds received for the gas stream, less the cost of compression, gathering and dehydration, as set forth above.

“13. The parties to the leases, all in accord with industry custom, practice, and usage at all pertinent times, intended to use the word ‘sold’ in the gas royalty clause or relate to the point in time of executing the contract of sale, intended that ‘market value at the well’ be fixed and determined as of the time of the execution of the contract of sale, and intended that the prices fixed by the contract less the marketing costs, if any, would establish the market value at the well. This intention is also evidenced by the provisions of Division Orders agreed to by the parties.”

In the Conclusions of Law, the trial Court said: “The language of the gas royalty clause in leases involved in this case is substantially different from the Vela lease.” The Court “concludes that the sales proceeds of the gas was intended to be the limit of the royalty obligation on gas produced from these leases.” In an alternative conclusion, the Court held that market value must be based on sales of gas comparable in time and prior to the drastic increase in price in 1972. The Court did reach other conclusions of law including ones concerning the division orders which were found to constitute a practical and reasonable construction placed upon the royalty provisions of the leases by the parties themselves and to be a binding contract until they were revoked.

The gas royalty clause in oil and gas leases is discussed at length in Chapter 40 of Kuntz, The Law of Oil and Gas, Vol. 3 (1967), with sections on Evolution of the Gas Royalty Clause; Provision for Fixed Gas Royalty; Provisions for Delivery of Royalty Gas in Kind; and Provisions for Payment of Value or Proceeds from Sale of Royalty Gas. In the early days of operations, there was practically no market for natural gas, but it was recognized that “if such gas were to be used off of the premises or sold, then such gas had a demonstrated value and the lessee should be required to make a fixed periodic payment to the lessor while the gas was so used or sold.” Kuntz, supra, Sec. 40.1. Where gas was used on the premises, it was thought to be to the benefit of both the lessor and the lessee and no royalty was due. The early leases generally provided for a fixed annual gas royalty of a few hundred dollars. Kuntz, supra, Sec. 40.2. Although some leases eventually provided for the delivery of royalty gas in kind, the more common provision provided for the payment of the gas royalty in money. Kuntz, supra, Sec. 40.4. Some of the first provisions for payment in money provided that the lessee agrees to pay an amount to be determined by the proceeds of the sale of gas. Kuntz, supra, Sec. 40.4. A second type of gas royalty clause provided that the lessee agrees to pay an amount to be determined by the market value or market price of the gas produced. Kuntz, supra, Sec. 40.4. “It [was] not uncommon for a gas royalty clause to combine the two types just mentioned and to use the market value to determine the royalty if there are no sales at the well and to use the sale price if there are sales.” Kuntz, supra, Sec. 40.4.

In the Vela case, supra, the lease contained two separate provisions for royalty on gas. The first was with regard to wells where gas only was found, and in such instance the royalty was Vsth of the market price at the well for gas used off the premises or sold. The second provision was on gas produced from any oil well. On such gas, the lessee was required to pay ⅛⅛ of the market value of such gas if used for the manufacture of gasoline, but if the gas was sold by the lessee, then the royalty was Vsth of the net proceeds derived from the sale of such gas at the well. In that case, all of the gas was being produced from gas wells and, therefore, the Court was not concerned with the interpretation or meaning of the “net proceeds” clause which was applicable only on the sale of casinghead gas.

In three of the Butler leases, the parties provided for a gas royalty of Vsth of the market value at the well of gas used off the premises or sold,¹ as in the Vela gas well clauses, but then added another clause to provide that on gas sold at the wells, the royalty would be Vsth of the amount realized from such sale, similar to the provision in the Vela lease on the sale of casinghead gas. The question immediately arises as to whether or not the “provided” clause providing for a royalty based upon the “amount realized from such sale” conflicts with the earlier clause for royalty based upon “market value.” We are compelled to construe the clauses, if possible, so as to give meaning and effect to both clauses and to nullify neither of them. Benge v. Scharbauer, 152 Tex. 447, 259 S.W.2d 166 (1953); Southland Royalty Company v. Pan American Petroleum Corporation, 378 S.W.2d 50 (Tex.1964). Therefore, we construe the gas royalty clause to provide that there shall be a royalty of Vsth of the market value at the well “on gas used off the premises” and “on gas sold other than at the wells,” and that “on gas sold at the wells” the royalty shall be ⅛⅛ of the amount realized from such sale. Such construction is clearly consistent with the opinion in the Vela case, since the Court in that case pointed out that the parties “might have agreed that the royalty on gas produced from a gas well would be a fractional part of the amount realized by the lessee from its sale.” In this case, the parties did so agree in three of the four leases with which we are concerned.

We next turn to the issue of whether or not the gas sold under Leases Nos. 510294, 510296, and 510292 was “sold at the wells” as found by the trial Court. The testimony of Mr. Gruy, as noted earlier, certainly supports that finding. Mr. Powell said he would not put a footage limitation on how far a sale could be made from the Christmas tree at the wellhead to the point of delivery and still be a sale at the well. His position was that a sale “off the premises” could not be at the well. But it must be noted that the parties did not use mutually exclusive terms such as “on the premises” and “off the premises,” or “at the well” and “away from the well” in the two clauses with different provisions for royalty payments. The clause based on “amount realized” from a sale “at the well” has no limiting language requiring the sale to be “on the premises.” In Skaggs v. Heard, 172 F.Supp. 813 (U.S.D.C.Tex.1959), Judge Allred held under a gas royalty clause that a sale at a separator 320 feet from the wellhead was a sale “at the well” as opposed to being a sale not at the well and off the leased premises. Obviously, the issue was not as clearly drawn in that case because of the different language in the royalty clause. Nevertheless, it points up the fact that a sale may occur “at the well” even though delivery is made several hundred feet from the Christmas tree. Certainly, both Mr. Powell and Mr. Gruy recognized this in their testimony. Thus, we expressly approve the trial Court’s finding of fact No. 12 that the gas sold under the Butler leases was sold at the wells. We also agree with the conclusion of law No. 6 that the royalties paid the Appellants were based on the amount realized from the sale of gas as provided for in Leases Nos. 510294, 510296, and 510292, and that no additional royalties are due on those leases. All of the Appellant’s points of error contending to the contrary are overruled.

As to Lease No. 510266, the royalty is ½6⅛ to the Veteran’s Land Board and ½6 th to the Butlers of the market value at the well of all gas produced and saved from the leased premises. Believing that the Vela case controls as to this lease provision, we hold that market value means the prevailing market value at the time of the sale and sale occurs at the time of delivery to the purchaser. Texas Oil & Gas Corporation v. Vela, supra; Brown, The Law of Oil and Gas Leases, Sec. 6.09 (1977); Hemingway, The Law of Oil and Gas, Sec. 7.4 (1971).

The next question is whether or not the division order, with the language quoted earlier, had the effect of changing the gas royalty from an amount based on market value at the well to an amount based on net proceeds at the well as provided for in the division order.

The trial Court concluded that the division orders were binding contracts until revoked. That holding finds support in J. M. Huber Corporation v. Denman, 367 F.2d 104 (5th Cir. 1966); Phillips Petroleum Co. v. Williams, 158 F.2d 723 (5th Cir. 1946). Also see 5 S.Tex.L.J. 1 at 14 (1960). A contrary holding appears in Craig v. Champlin Petroleum Company, 300 F.Supp. (U.S.D.C.Okl.1969) aff’d, 421 F.2d 236 (10 Cir. 1970), where the Court said:

“ * * * The plaintiffs, being entitled to the prevailing market price for gas in the field where produced, are not estopped to claim royalties based on market price because they had accepted royalties under a 20-year gas contract providing for lower rates, since the lessee could contract for the sale of the gas, and without interference by the lessors. * * * »

We conclude that the better result is reached in the Craig case. Basically, a division order sets forth the interest of each owner for purposes of payment by the purchaser of the product being sold. It is executed without any consideration. As to Lease No. 510266, there was no provision for payment based on proceeds from the sale of gas. Exxon cannot claim an estop-pel in this case because there was no reliance to its detriment. Chicago Corporation v. Wall, 156 Tex. 217, 293 S.W.2d 844 (1956), is therefore distinguishable.

Thus, we believe that the Butlers are entitled to recover from Exxon a gas royalty payment for all gas sold under Lease No. 510266 based on market value at the time of delivery during the period from October 1, 1972, until October 1, 1975. In making such determination, we disapprove of the trial Court’s alternative conclusion that market value should be based upon the volume-weighted average of all committed gas delivered in the market area. While we may not make initial findings for the first time on appeal, we believe that since Exxon did not offer testimony to refute the conclusions reached by Mr. Powell as to market value, that the trial Court may take those figures of Mr. Powell as to market value each quarter and multiply them by the amount of gas delivered each quarter under Lease No. 510266 and properly arrive at the royalty due,² plus such determination as may be made concerning interest for past due sums.

We sustain Appellant’s points of error concerning Lease No. 510266 which are consistent with this result. All others are overruled. The judgment of the trial Court is affirmed in part and in part reversed and remanded.

1 . Compare the results in Reynolds v. McMan Oil & Gas Co., 11 S.W.2d 778 (Tex.Comm.App.1928), where the lease provided a fixed royalty for gas “used off the premises” but not for gas “sold”, and Magnolia Petroleum Co. v. Connellee, 11 S.W.2d 158 (Tex.Comm.App.1928), which provided a fixed royalty for casinghead gas “sold or used off the premises.”

2 . Hemingway, supra, Sec. 7.4(C) at page 319, notes “that the cases, where actual sales of gas or petroleum products exist in the field, treat market value the same as market price, and generally indicate that an actual market in the field will be practically conclusive evidence of value.”