Case Name: ENRON OIL AND GAS COMPANY, Successor to Belco Petroleum Corporation, Plaintiff and Appellant, v. STATE of Utah, DEPARTMENT OF NATURAL RESOURCES, DIVISION OF STATE LANDS AND FORESTRY, and the Director of State Lands, Defendants and Appellees
Court: Utah Supreme Court
Jurisdiction: Utah
Decision Date: 1994-01-05
Citations: 871 P.2d 508
Docket Number: No. 910057
Parties: ENRON OIL AND GAS COMPANY, Successor to Belco Petroleum Corporation, Plaintiff and Appellant, v. STATE of Utah, DEPARTMENT OF NATURAL RESOURCES, DIVISION OF STATE LANDS AND FORESTRY, and the Director of State Lands, Defendants and Appellees.
Judges: HALL and HOWE, JJ., concur.
Reporter: Pacific Reporter 2d
Volume: 871
Pages: 508–515

Head Matter:
ENRON OIL AND GAS COMPANY, Successor to Belco Petroleum Corporation, Plaintiff and Appellant, v. STATE of Utah, DEPARTMENT OF NATURAL RESOURCES, DIVISION OF STATE LANDS AND FORESTRY, and the Director of State Lands, Defendants and Appellees.
No. 910057.
Supreme Court of Utah.
Jan. 5, 1994.
Rehearing Denied April 18, 1994.
R. Paul Van Dam, Atty. Gen., for State Lands and Forestry, State of Utah, amicus Utah State Tax Comm’n, Dept, of Natural Resources, Director of State Lands, and ami-cus Utah State Bd. of Educ.
Steven F. Alder, Asst. Atty. Gen., for Dept, of Natural Resources, State Lands and Forestry, and State of Utah.
Gale K. Francis, Asst. Atty. Gen., for ami-cus Utah State Tax Comm’n.
J. Gary McCallister, Salt Lake City, for amicus Utah State Bd. of Educ.
A. John Davis, III, Dante L. Zarlengo, Salt Lake City, for Enron Oil & Gas.
Phillip William Lear, Salt Lake City, for amicus ANR Production Co., amicus Coastal Oil & Gas Corp., amicus CIG Exploration, Inc.

Opinion:
STEWART, Associate Chief Justice:
Enron Oil and Gas Company produces and sells gas from school trust lands that it leases from the state. Enron appeals from a district court decision granting summary judgment to the Utah Department of Natural Resources, Division of State Lands. The summary judgment affirmed the Division's assessment of royalties on ad valorem tax reimbursements paid to Enron by Mountain Fuel Supply Co. and Colorado Interstate Gas (CIG) pursuant to gas purchase contracts for gas produced on state lands. We affirm.
I.
The Division of State Lands audited Enron's royalty payments on 52 oil and gas leases on school trust lands in Uintah County. Enron paid royalties to the State based on a price for gas that did not include ad valorem and severance tax reimbursements paid to Enron by Mountain Fuel and CIG. In 1987, the Division informed Enron that it owed $91,000 in royalty payments on the amount of the tax reimbursements. Enron appealed to the district court from a denial of a request for a redetermination of the royalty assessment. The district court held that the tax reimbursements were subject to royalty payments because they were part of the "market value" of the gas under the terms used in Enron's lease with the State.
On this appeal, Enron argues that ad valo-rem tax reimbursements paid to it by gas purchasers cannot be considered in determining the "market value" of the gas, as that term is used in the leases. Enron also asserts that including tax reimbursements as part of the market value or price of gas conflicts with the Natural Gas Policy Act (NGPA) of 1978, which sets the maximum lawful price for gas.
Under the state leases, Enron agreed to pay the State a 12½% royalty based on the "reasonable market value at the well of all gas produced and saved or sold from the leased premises" and that "in no event shall the price for gas be less than that received by the United States of America for its royalties from gas of like grade and quality from the same field." In full, the lease royalty provision states:
Gas — LESSEE also agrees to pay LESSOR twelve and one half per cent (12½%) of the reasonable market value at the well of all gas produced and saved or sold from the leased premises. Where gas is sold under a contract, and such contract -has been approved in whole or conditionally by the LESSOR, the reasonable market value of such gas for the purpose of determining the royalties payable hereunder shall be the price at which the production is sold, provided that in no event shall the price for gas be less than that received by the United States of America for its royalties from gas of like grade and quality from the same field.
(Emphasis added.)
During the audit period, Enron sold gas it produced from the Chapita Wells Unit Area to Mountain Fuel. Under the gas purchase agreement, Mountain Fuel agreed to pay Enron a price for its gas computed pursuant to the following provision:
The price of any gas whose maximum base price is regulated by the FERC or by a properly constituted state authority at the time of delivery ("regulated gas") shall be the highest applicable base price, including all applicable escalations, on the date the gas is delivered.... The total price for regulated gas shall consist of the base price, reimbursements of costs borne by the Seller for which reimbursement by Buyer is permitted under the applicable statutes and regulations, and tax reimbursements made pursuant to Section VII-S.
(Emphasis added.) Under this contract it is clear that the "total price" paid Enron included the "base price" and "tax reimbursements."
Enron sold gas produced from the Natural Buttes Unit Area to CIG at a price to be computed pursuant to the following provision in the gas purchase contract:
Subparagraph (c) of Paragraph 5.1 of ARTICLE V — PRICE shall be amended by adding thereto the following:
Such rate paid pursuant to this paragraph shall include the highest prices allowed by the Federal Energy Regulatory Commission (FERC) under Section 107(c)(5) of the Natural Gas Policy Act of 1978 (NGPA) for gas delivered to Buyer by Seller from formations that qualify for such prices. Such rate shall change to conform to all such adjustments and escalations and any revisions on the date they become effective as to the sale of gas covered hereby.
(Emphasis added.) This provision makes clear that the price paid Enron included "the highest prices allowed by the Federal Energy Regulatory Commission."
II.
The price of natural gas is regulated by the Federal Energy Regulatory Commission (FERC) (previously the Federal Power Commission), which sets the maximum price producers may charge for gas. Historically, gas producers sought to increase the amount they received for gas by requiring purchasers to pay, in addition to the stated price, an amount equal to the ad valorem and severance taxes that the producers paid to the state. Gas purchasers paid the amount of the taxes even though it was in addition to the maximum price permitted by the FERC. Thus, gas purchasers, although not legally liable for the taxes, paid more than the maximum price allowed, under the guise of assuming one of the producer's costs of production. As a result, the so-called tax reimbursements increased the price that the producers received for the gas.
There is a long-standing practice of gas producers requiring gas purchasers to pay tax reimbursements. See, e.g., Amoco Prod. Co., 29 I.B.L.A. 234 (1977); Wheless Drilling Co., 13 I.B.L.A. 21 (1973). In fact, the NGPA specifically allowed tax reimbursements to be added to the maximum price fixed:
(a) . a price for the first sale of natural gas shall not be considered to exceed the maximum lawful price applicable to the first sale of such natural gas . if such first sale price exceeds the maximum lawful price to the extent necessary to recover.
(1) State severance taxes attributable to the production of such natural gas and borne by the seller....
15 U.S.C. § 3320(a) (1982), repealed by 103 Stat. 158 (effective Jan. 1, 1993).
Whether Enron was obligated to pay a royalty on the tax reimbursement payments depends on whether the payments are part of the "reasonable market value" of the gas sold by Enron as that term is used in the state leases. The leases define "reasonable market value" as the price for which the gas is sold but not less than the price received by the United States.
Enron concedes that the market value of gas is the highest price that a willing buyer would agree to pay a willing seller. The stated price is not, however, the sole measure of market value in this case. Severance taxes are a cost of production for the producer. Shifting that cost to the buyer by a tax reimbursement is simply additional consideration to the seller. In short, the stated price plus tax reimbursements constitute the consideration that a willing buyer pays a willing seller and together they equal the "reasonable market value" of the gas. In Enron Oil & Gas v. Lujan, 778 F.Supp. 348, 352 (S.D.Tex.1991), aff'd, Enron Oil & Gas Co. v. Lujan, 978 F.2d 212 (5th Cir.1992), the court stated, "[R]oyalty is assessed on value of production as reflected by the market. In the marketplace, Enron is able to sell its gas for a maximum legal price plus reimbursement of the severance tax.'' (Emphasis added.)
If Enron had agreed to sell the gas solely for the NGPA price, Enron would have paid the state severance taxes, thereby reducing its net proceeds from the sale. Because the buyers were willing to pay a price higher than the stated price by the amount of the severance taxes imposed on the seller, the true market price or value received by Enron was the stated price plus tax reimbursements. See Enron Corp., 106 I.B.L.A. 394, 397 (1989). To rule otherwise would allow Enron to "determine the value of production simply by allocating the value they will receive under different categories designated as being other than the 'price,' yet all relating to the production." Amoco Prod. Co., 29 I.B.L.A. 234, 237-38 n. 2 (1977).
The "reasonable market value" or "price at which the production is sold" under Enron's lease is ejqJieitly stated in the Mountain Fuel contract: "The total price for regulated gas shall consist of the base price . and tax reimbursements." The language in the CIG gas purchase contract is not as clear with respect to specifying consideration to be paid Enron, but it is nevertheless clear that the total consideration is the stated price plus the tax reimbursement. That agreement refers to the "highest prices allowed by Federal Energy Regulation Commission."
Enron's position is especially untenable in view of the lease language providing that "in no event shall the price for gas be less than that received by the United States of America for its royalties from gas of like grade and quality from the same field." This provision places a floor on the price of gas for royalty calculations and ensures that the leases are "in the best interest of the state," as required by Utah Code Ann. § 65-1-18 and the terms of the state school land trust. The price of gas for determining federal royalties has consistently been held to include tax reimbursements. E.g., Enron Oil & Gas Co. v. Lujan, 978 F.2d 212, 216 (5th Cir. 1992); Hoover & Bracken Energies, Inc. v. United States Dep't of Interior, 728 F.2d 1488, 1492 (10th Cir.1988); Amoco Prod. Co., 29 I.B.L.A. 234, 238 (1977); Wheless Drilling Co., 13 I.B.L.A. 21, 32 (1973). "If the market value or amount realized is higher than the federal floor, royalties must be paid on the basis of market value or amount realized. Conversely, if the . market value is lower than the federal floor, royalties must be paid on the basis of the federal floor." State v. Moncrief, 720 P.2d 470, 474 (Wyo.1986). If Enron were to sell gas based at a price less than the floor provision when the reasonable market value would yield a higher price, the Division could reject such a contract. See Moncrief, 720 P.2d at 474-75.
Enron argues that including the tax reimbursements for royalty purposes unjustly enriches the State because state school section gas is not subject to ad valorem taxes and if the State were to take its gas in kind, it could receive only the NGPA price without the tax reimbursement. The argument is without merit for two reasons. First, it assumes that the only value to the State of gas in-kind is what the State could sell the gas for. That is not so. "If . the Government were to take its royalty interest in kind, the implicit assumption would be that it [has] a use for the gas. The value of [the] gas is, therefore, properly computed as the price which the [State] would pay on the open market if it were purchasing the gas as an ordinary purchaser." Hoover & Bracken Energies, Inc., 52 I.B.L.A. 27, 37 (1981) (emphasis added).
Second, Enron's argument seeks to capture for itself the benefit of the tax immunity that the State enjoys. A similar argument based on federal immunity to state taxation was rejected by the United States Court of Appeals for the Tenth Circuit. That court held that the benefit of the federal government's immunity from state taxation flows to the federal government, not to lessees of federal lands:
"The fact that the United States cannot be assessed state severance tax does not depreciate the value of the gas to it. Immunity from state taxation is a function of the Federal Government's sovereignty, which prevents the state from assessing a severance tax. This benefit flows to the Government, not the lessor."
Hoover & Bracken Energies, Inc. v. United States Dep't of Interior, 723 F.2d 1488, 1491 (10th Cir.1983) (emphasis in original) (quoting Hoover & Bracken Energies, Inc., 52 I.B.L.A. 27, 37 (1981)). Clearly the State, not Enron, is entitled to the benefit of the immunity of state lands from taxation.
The argument is made by the dissent that Enron receives the tax reimbursements in return for its commitment to a long-term contract, not as consideration for the gas itself. There is, however, no practical difference between consideration for the gas and consideration for a commitment to a long-term contract. Gas is typically sold pursuant to long-term contracts. In any event, the distinction the dissent draws is not in accord with economic realities. Severance taxes are a seller's cost of production, and when such a cost is paid for by a buyer, the value of the gas is increased accordingly. See Amoco Prod. Co., 29 I.B.L.A. 234, 237-38 n. 2 (1977).
Finally, Enron claims that assessing royalties on the tax reimbursements violated the Natural Gas Policy Act of 1978. This argument has been rejected by the federal courts and is without merit. E.g., Enron Oil & Gas Co. v. Lujan, 978 F.2d 212, 216 (5th Cir. 1992); Hoover & Bracken Energies, Inc. v. United States Dep't of Interior, 723 F.2d 1488, 1491-92 (10th Cir.1983).
Affirmed.
HALL and HOWE, JJ., concur.
. Enron owns 12 additional leases which were also subject to the Division's audit, but because those leases contain different royalty provisions, our ruling pertains only to the 52 leases.
. The leases were entered into pursuant to Utah Code Ann. § 65-1-18, repealed by 1988 Utah Laws ch. 121, § 18, which provided:
All mineral leases issued by the board shall contain such terms and provisions as the board deems to he in the best interest of the state and shall provide for such annual rental and for such royalty as the land board shall deem fair and in the best interest of the state of Utah, but the annual rental shall not be less than fifty cents per acre per annum nor more than one dollar per acre per annum and the royalty shall not exceed 12'k% of the gross value of the product at the point of shipment from the leased premises.
(Emphasis added.)