Opinion ID: 2518343
Heading Depth: 2
Heading Rank: 1

Heading: Market Value of Gas at the Wellhead

Text: ¶ 17 Market value is the price negotiated by a willing buyer, not obligated to buy, and a willing seller, not obligated to sell, in a free and open market. Johnson v. Jernigan, 1970 OK 180, ¶ 5, 475 P.2d 396, 398. The term market value has been construed as synonymous with actual value. Katschor v. Eason Oil Co., 1936 OK 705, ¶ 0, 63 P.2d 977 (syllabus 3 by the court). ¶ 18 There are three basic methods of establishing the market value at the wellhead. The first and most preferred is an actual sale reached through arm's-length negotiations. Tara Petroleum Corp. v. Hughey, 1981 OK 65, 630 P.2d 1269. The rule adopted in Tara is: [If a] producer enters into an arm's-length, good faith gas purchase contract with the best price and terms available to the producer at the time, that price is the `market price' and will discharge the producer's gas royalty obligation. Id. at ¶ 14, 630 P.2d at 1273. Such a sale establishes the market value. Id. In this case, there was not an actual arm's-length sale at the wellhead. ¶ 19 If the market value at the wellhead is not established by an actual arm's-length sale at the best price available, then the market value may be constructed by evidence of the prevailing market price. Cimarron Utils. Co. v. Safranko, 1940 OK 181, ¶ 0, 101 P.2d 258, 259 (syllabus 1 by the court). Arm's-length wellhead sales or offers of purchase from the same well and close in time to the sale at issue are proof of the prevailing market price. Proof of arms'-length sales from other wells in the vicinity can also be used to establish the prevailing market price. See Johnson, 1970 OK 180 at ¶ 5, 475 P.2d at 398. The more similar in quality, quantity, delivery pressure, and geographical location of gas produced from other wells, the more probative and compelling are their sales in determining the prevailing market price. ¶ 20 In addition to evidence of sales of like gas, the market value may be established by the work-back method. Wood v. TXO Production Corp., 1992 OK 100 at n. 1, 854 P.2d at 882 n. 1; Katschor, 1936 OK 705, ¶¶ 0, 32, 63 P.2d 977, 981 (syllabus 4 by the court). Under the work-back method, the market value at the wellhead is calculated by subtracting allowable costs and expenses from the first downstream, arm's-length sale. Katschor, 1936 OK 705 at ¶¶ 0, 32, 63 P.2d at 977, 981(syllabus 4 by the court). When the gas is marketable at the wellhead, the reasonable post-production costs may be charged against the royalty payments. Mittelstaedt v. Santa Fe Minerals, Inc., 1998 OK 7, ¶ 2, 954 P.2d 1203, 1204. This is so because the referenced starting point in the calculations is the value of the gas after processing and the royalty owners are entitled only to the value of the gas that is marketable at the wellhead. The burden is on the producer to justify the costs and expenses. Id. Because it is in the producer's best interest to maximize the costs and expenses, the courts must carefully scrutinize the figures to determine the correct amount. See Tara, 1981 OK 65 at ¶ 20, 630 P.2d at 1275. ¶ 21 In Mittelstaedt, the lease provided for royalty payments of 3/16 of the gross proceeds received for the gas sold. Id. at ¶ 1, 954 P.2d at 1204. The clause prohibits a producer from deducting the costs of obtaining a marketable product. Id. at ¶ 2, 954 P.2d at 1205. However, the costs incurred after the gas becomes marketable may be apportioned between the royalty owner and the producer. Id. at ¶ 2, 954 P.2d at 1205. In order to burden the royalty interest with a proportionate share of the costs, the producer must 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. Id. at ¶ 2, 954 P.2d at 1205. ¶ 22 A royalty owner has a right to be paid on the best price available. Johnson, 1970 OK 180 at ¶ 14, 475 P.2d at 399; see Tara at ¶ 20, 630 P.2d at 1274. When the actual value is not obtainable because of a producer's self-dealing, the courts will carefully scrutinize the transactions on which the royalty payments are based. Tara, 1981 OK 65 at ¶ 15, 630 P.2d at 1274. Whenever a producer is paying royalty based on one price but it is selling the gas for a higher price, the royalty owners are entitled to have their payments calculated based on the higher price. Id. The plaintiffs here are entitled to have their royalty payments based on the prevailing market price or the work-back method, whichever one results in the higher market value. We hold that an intra-company gas sale cannot be the basis for calculating royalty payments. Because there remain unresolved questions of fact on whether the respondents underpaid royalties, partial summary judgment on this issue was improper. ¶ 23 The plaintiffs' also complain that they were not paid for the scrubber oil and drip condensates sold to third-parties after processing. Texaco posits that they are not required to pay royalties separately on the scrubber oil and drip condensate because they were taken into consideration when the third-party POP contracts were negotiated. Texaco continues that the scrubber oil and drip condensate are reflected in the percentages paid under the third-party POP contracts and in the plaintiffs' royalty payments. This is a matter of fact for the trial court to consider on remand. However, when using the work-back method, the court must consider their value in calculating the market value at the wellhead. Katschor, 1936 OK 705 at ¶ 29, 63 P.2d at 981.