'No. 90-632 IN THE SUPREME COURT OF THE STATE OF MONTANA 1991

GARY DRILLING COMPANY, Plaintiff and Respondent,

THE STATE OF MONTANA DEPARTMENT OF REVENUE; THE STATE OF MONTANA; THE COUNTY OF YELLOWSTONE; TREASURER OF YELLOWSTONE COUNTY; and ASSESSOR OF YELLOWSTONE COUNTY, Defendants and Appellants.

APPEAL FROM: DistrictCourt of theThirteenth Judicial District, In and for the County of Yellowstone, The Honorable G. Todd Baugh, Judge presiding.

COUNSEL OF RECORD: For Appellants: Paul Van Tricht (argued),Montana Department of Revenue, Helena, Montana; Dennis Paxinos, Yellowstone County Attorney, Billings, Montana; David W. Hoefer, Deputy County Attorney, Billings,Montana For Respondent: Raymond 

### K. Peete (argued), Attorney at Law, Billings,Montana

Submitted: September 18, 1991 Decided: November 8, 1991 Filed:Justice Terry N. Trieweiler delivered the opinion of the Court. RespondentGary Drilling Company (Gary) filed a complaint for declaratory judgment in the Thirteenth Judicial District Court in Yellowstone County, requesting the District Court to declare that the oil produced from certain wells should be taxed as "new productionu rather than old or existing production. The District Court entered judgment in favor of Gary. The Department of Revenue, the County of Yellowstone,and theTreasurer andAssessor of Yellowstone County appeal from the District Court's decision. We affirm. The issue presented is whether the District Court erred in determining that the oil produced from respondent's wells should be assessed as "newprodu~tion'~ under 1 15-23-601(2), MCA (1985). The oil wells in question are located on Section 3, Township 6N,Range 32E,Yellowstone County. Themineral interests in and under Section 3 are owned an undivided 50 percent each by Ralph and Sarah Botts,husband andwife, and by the estate of Inola Botts

# . In 1980,Inola Bottsgranted anoil and gas lease covering her mineral interests in and under all of Section 3. This lease was later assigned to BeartoothOil & Gas Company, et al. (Beartooth). In November 1984, Ralph and Sarah Botts granted an oil and gas lease to respondent. This lease covers all of their mineral interest in and under all of Section 3, i.e., the same surface description as Beartooth's lease.In December 1984, Beartooth began drilling a well known as Botts No. 1 in the SE4 of the NE4 of Section 3. This well was completed in the Amsden formation in May 1985. Botts No. 1 produced oil, in limited quantities, between January 1985 and January 1986, when it was abandoned. A total of 1258 barrels of oilwereproduced fromBottsNo. 1. Beartooth statedthat the cost of drilling and operating Botts No. 1 was more than $375,000; the value of that production was in the order of about $32,000. In early 1985, Beartooth petitioned the Montana Board of Oil and Gas conservation to determine that the portion of Section 3 containing Beartooth's well was an appropriate well-spacing unit for oil production under 

### 5 82-11-201, et sea., MCA. In order to prevent waste of oil or gas, the Board is authorized to establish well-spacing units for any pool of oil or gas. Generally, the order establishing well-spacing units directs that only one well may be drilled and produced from the common source of supply on a spacing unit. Section 82-11-201,MCA. The Board ordered that all mineral interests in theAmsden formation underlying the E3 of the NE& of Section 3 were to be pooled. Pooling is intended toprovide foran equitable sharing of the oil or gas produced and the expenses of production among the persons owning interests in the pool. If an owner refuses to pay his share of the costs of a well, the Board can order his share to be paid, but only out of the production from the well. Section 82-11-202,MCA. Gary refused to pay its share of the costs from Beartooth's BottsNo. 1. Gary did not bear any of the expenses ofBeartooth's well, except for those costs Beartooth could recover from Gary's share of the oil produced from Botts No. 1. Gary contestedtheBoard's pooling order. By late 1985,after it had become clear that Beartooth's Botts No. 1 well was not producing much oil, Beartooth agreed that Gary could drill an additional well in the spacing unit, and supported Gary's application for a modification of the pooling order. The Board granted Gary's application to drill an additional well in the spacing unit. In December 1985, Gary began drilling a well known as Botts No. 2-3 in the NE4 of the NE4 of Section 3, about 1340 feet away from Beartooth's well. Botts No. 2-3 began producing oil in January 1986, producing more than 80,000 barrels of oil in 1986 and over 50,000barrels in 1987. InJune 1986,Gary begandrilling another well, BottsNo. 1-3, in the NW4 of the NEJ of Section 3 (e., not within the well-spacing unit). Thiswell onlyproduced 246 barrels of oil in 1986 and 4039 barrels in 1987. Both of Gary's wells, like the Beartooth well, produced in theAmsden formation. During the 1985 legislative session, the legislature amended the statutes governing the oil and gas net proceeds tax. 1985 Mont. Laws 695. "New production,I' as defined in 5 15-23-601(2)

## , MCA (1985), received favorable treatment, being taxed at seven percent of net proceeds. Section 15-23-607(2)(a)

## , MCA (1985)

# . Gary believed that theproduction from its BottsNos. 2-3 and 1-3 should be taxed as "new production." Appellants, taxcollectors forYellowstoneCountyand theStateofMontana, thought otherwise, and classified the production from Botts Nos. 2-3 and 1-3 as existing or old production. Gary paid the net proceeds taxes to Yellowstone County under protest. InJanuary 1988,Gary fileda complaint fordeclaratory relief in the Thirteenth Judicial District Court. Gary requested the District Court to declare that the production attributable to the Ralph and Sarah Botts lease from Botts Nos. 2-3 and 1-3 was "new productiontg under § 15-23-601(2)

## , MCA (1985)

## , and that the taxes be reduced accordingly. On September 5, 1990, the District Court entered judgment in Gary's favor. Appellants appeal from this order. The issue in this appeal is whether the District Court erred indetermining that the oilproduced fromGary's wells constitutes Itnew productiongt within themeaning of 3 15-23-601(2), MCA (1985). The statute states: Theterm Ifnew productiontg means theproduction of natural gas, petroleum, or other crude or mineral oil from any lease that has not produced natural gas, petroleum, or other crude ormineral oil during the 5 years immediately preceding the first month of qualified new production.

[Emphasisadded.] The dispute centers around the meaning of the term tglease.lt Appellants contend that ggleasegg means 'la tract of land." The Department of Revenue so defined the word "leasew in its Administrative Regulations,e.g., 42.25.1001(1), ARM (1985). Under theDepartmentofRevenuegsinterpretation,Gary'sproductionwould not be Ifnewproduction," because Beartooth produced oil from the same tract of land within the pr ceding five years. 

## 5Gary contends, and the District Court agreed, that ttleasetf

means contract or legal arrangementtl' under which Gary was permitted togoon the land and drill for oil. By this definition, Garytsproduction was "new productionItbecause Gary drilled its wells under a separate contractual agreement. We are persuaded that the word ItleaseItt as used in this statute, refers to the contract or legal arrangement giving the driller the right togo on the land and drill foroil. The ttleaselt is not ItthelandIt' but is a separate interest. This definition is consistent with customary usage in the oil and gas industry. WilliamstandMeyerstManual of Oil and Gas Terms defines leaseas: "(1) The conveyance of a nonfreehold interest in land. (2) The instrument by which a leasehold or working interest is created in minerals.t1 8Williams and Meyers, Oil and Gas Law 503-04 (1987). Further,by so construing theword "leaseI1in the instant case,we effectuate the legislaturetspublic policy of encouraging new production on newly leased lands. Alternatively, the Department of Revenue contends that the prior production fromBeartoothts well shouldbe attributedtoGary by virtue of the pooling order issued by the Board of Oil and Gas Conservation. As authority for this contention, the Department of Revenue cites three sections of Title 82, ch. 11,MCA (Oiland Gas Conservation), fifi 82-11-202(1), -211(1), and -212, MCA. We note, however, that these statutes are specifically concerned with oil and gas conservation and the prevention of waste, rather than taxation. Theportions of the statutes cited by the Department ofRevenue were all enacted several years before the 1985 amendments of 

### 5 15-23-601(2)

## , MCA, distinguishing "new productionw from existing production, and it does not appear that the earlier conservation statutes were drafted in contemplation of a later statute containing a new classification of oil production for tax purposes. We conclude that the cited statutes are not helpful in construing the tax statute at issue in this case. Gary contends, and we agree, that it is unfair to penalize Gary economically for Beartooth's production since Gary did not receive any benefit from Beartooth's production, and in fact, refused to participate in it. Beartooth's Botts No. 1 well was drilled by a different operator under a separate contractual agreement, executed several years before Gary's lease agreement. Gary had no right or ability to control Beartooth's operations. Gary did not join in drilling Beartooth's well, and received no economic benefit from it. Gary was the sole operator of its own wells under a separate lease. We agree with the District Court that Beartooth'sproduction shouldnotbe charged toGary. Theoil produced from Gary's Botts Nos. 2-3 and 1-3 wells was production from a new lease which had not produced during the firstpreceding five years. The District Court correctly determined that the production from Gary's wells constituted "new productionw under 15-23-601(2), MCA (1985)

# . Affirmed.Weconcur:

L_C ,

## ,. ~href J'ustice 4JusticeR. C. McDonough re'spectfullydissents. The general oil and gas net proceeds tax, which is involved here, is in lieu of a year-to-year ad valorem property tax on the oil and gas 

### in the ground. The actual tax is arrived at by applying the applicable local millage against 100% of the net proceeds value of theproduced oil and gas. The specific sections involved were an exception to the application of the general net proceeds tax and provided that net proceeds for new production would be considered as the equivalent of the gross saleproceeds, and instead of applying the localmillage rate to the netproceeds value, however defined, levieda straight sevenpercent tax against the gross sale proceeds. See § 15-23-607, MCA (1985). The taxation of Ifnewproduction" is an exception to the general law taxing net proceeds of oil and gas. See the first sentences of 88 15-23-602 and-603, MCA (1985). The statute at issue, § 15-23-601, MCA (1985), reads as follows: (2) The term "new productionI1means the production of natural gas, petroleum, or other crude or mineral oil from any lease that has not produced natural gas, petroleum, or other crude or mineral oil during the 5 years immediately preceding the firstmonth of qualified new production.- (Emphasisadded.) WebsterfsSeventh New Colleqiate Dictionary, p. 480 states: lease \'les\n 1 : a contract by which one conveys real estate for a term of years or at will usu. for a specified rent;also : the act of such conveyanceor the term forwhich it is made 2 : a piece of land or property that is leased. We have previously said that when a taxing statute issusceptible to two constructi~nsand legislative intent is in doubt, relative to exemptions and deductions, the construction is tobe against the taxpayer and in favor of the taxing power. See, State ex rel. Anderson 

### v. State Board of Equalization (1957), 133 Mont. 8, 13, 319 P.2d 221;Anaconda Co. 

### v. Dept. of Revenue (1978), 178 Mont. 254, 258, 583 P.2d 421, citing Anderson. I realize that we are dealing with an exception and not a deduction or an exemption, but it is, in essence,the samebecause it is a net reduction of the general netproceeds tax. Themaxim: "Where the reason is the same, the rule should be the sameIvv applies here. See 5 1-3-202, MCA. If there is a doubt as to legislative intent then this being

an exception, such words should be construed against the taxpayer. Specifically, what is not clear is the meaning of the word ttleaseu if one looks at it in isolation but when used in the contextof vtproduction ofnatural gas,petroleum,or other crudeor mineral oil from any leasev1it becomes clear. The word tgfromvl refers to the source. Oil and gas areproduced from a place, real property and premises. For an example, the oil and gas leases involved herein and agreements of the lessees herein, provide in their text for oil and gas produced and saved from the premises. Oil and gas are notproduced fromawritten instrument or lease; if itwere tobe fromawritten lease, itwould beproductionunder or by virtue of a lease. The effect of the majority's construction is to give tax reductions on new production to those who have multiple writtenleaseswithproduction coming from the sameplace. For example, if minerals in the ground in a piece of land are owned by ten different owners as co-tenants, each gives a different written lease to a lessee or even the same lessee, such lessees then complete nine different additional development wells for each written lease adjacent to a producing well from the samevertical formationand pool. Thenine wellswould have the advantage of the tax reduction. However, a lessee who has one written lease covering two pieces of land, with a well on each, one five miles away from the other on an entirely different geological structure, would not receive the tax reduction even though the second well would be geologicallyconsiderednew production and the secondwell would be an expensive exploratory wildcat well and would open up a new field. Rules of constructionand logic support the reversal of the District Court.

Chief Justice J. A. Turnage: I concur in the dissent of Justice McDonough. 

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