Opinion ID: 567657
Heading Depth: 3
Heading Rank: 1

Heading: Production and Diamond Shamrock

Text: 9 In Diamond Shamrock, this court held that production, as used in a mineral lease prepared by the Department of Interior, means the actual physical severance of minerals from the ground. Diamond Shamrock, 853 F.2d at 1168. This holding made gas royalties under the lease there at issue due only on gas actually produced and not on take-or-pay payments received by the lessee-producer from the pipeline-purchaser. Id. 10 Several facts distinguish Diamond Shamrock from this case. Foremost, the cases concern different lease language. In Diamond Shamrock, the lessor received as royalty a fraction of the amount or value of production saved, removed, or sold whereas Frey is entitled to a fraction of the amount realized at the well from [the sale of gas]. Compare Diamond Shamrock, 853 F.2d at 1163 (emphasis added) with Frey, 708 F.Supp. at 786. Second, the Diamond Shamrock court applied federal law in determining the meaning of the Department of Interior leases there at issue, but we must predict how the Louisiana Supreme Court would allocate take-or-pay payments under the Lease. See, e.g., Piney Woods Country Life School v. Shell Oil Co., 905 F.2d 840, 851-52 (5th Cir.1990) (predicting that Mississippi Supreme Court would consider federal price ceilings in determining the meaning of market value in gas royalty contract). Finally, the Department of Interior as lessor wrote the Diamond Shamrock lease, while here, Amoco as lessee prepared the Lease and presented it to F & L for execution. So Diamond Shamrock does not control the result in this case. The Lease's paragraph 7(b) establishes 11 the royalty on gas sold by Lessee to be one-fifth ( 1/5) of the amount realized at the well from such sales. 12 The district court held that a 'sale' of gas cannot occur absent physical production and severance of the gas. Frey, 708 F.Supp. at 786. Though the court cited authority for the proposition that in Louisiana, gas apart from the mineral estate cannot be owned by the buyer until it is produced, see id., the court assumed that a thing must be owned to be sold. 1 However, under Louisiana law a 13 sale is sometimes made of a thing to come: as of what shall accrue from an estate, of animals yet unborn, or such like other things, although not yet existing. 14 LA.CIV.CODE ANN. art. 2450 (West 1952). More importantly, the court gives no explanation for why take-or-pay payments are not considered part of the total consideration for the right to take gas under the Morganza Contract. 15 The Lease affords royalty on the amount realized from sales, not on production. Cf. Diamond Shamrock, 853 F.2d at 1161; Killam Oil Co. v. Bruni, 806 S.W.2d 264, 266-67 (Tex.App.--San Antonio 1991, writ requested); State v. Pennzoil Co., 752 P.2d 975, 976 (Wyo.1988) (no royalty on take-or-pay payments where leases explicitly tie royalty to production). This court before has held that take-or-pay arrangements can effect a sale of gas that brings take-or-pay arrangements within the jurisdiction of the Federal Power Commission despite the possibility that the producer may not deliver any gas pursuant to arrangement. Callery Properties, Inc. v. Federal Power Comm'n, 335 F.2d 1004, 1021 (5th Cir.1964), rev'd on other grounds, 382 U.S. 223, 230, 86 S.Ct. 360, 364-65, 15 L.Ed.2d 284 (1965). That the Lease explicitly bases oil and miscellaneous mineral--but not gas--royalties on production strongly suggests that we not interpret production to be a prerequisite to royalties on gas. 2 See LA.CIV.CODE ANN. art. 2050 (West 1987) (each contractual provision must be interpreted in light of contract's other provisions). 16 Amoco contends that practical accounting difficulties should keep us from dividing recoupable take-or-pay payments between it and Frey. Amoco relies on the following Diamond Shamrock statement to support its argument: 17 [Requiring take-or-pay payments to be shared] would lead to absurd results. For example, if royalty is payable currently when the take-or-pay payment is made, what happens when the pipeline later takes make-up gas? If the fair market value of gas rises, the pipeline is usually responsible for paying for the make-up gas at the increased market value. The [lessor] gets its proportionate share of the increased market value as royalty for the make-up gas now taken. The lessee-producer then has to pay the additional royalty due on the increased fair market value, necessitating two royalty payments on one purchase of gas. 18 If the price of gas drops, depending on the contract, the pipeline-purchaser could be due a refund. If the pipeline gets a refund, then certainly it would be equitable for the lessee-producer to get a refund on overpaid royalties. A problem arises here with the length of the make-up period, usually 7 years, being longer than the statute of limitations [applicable to lessees' royalty refund claim]. In this situation, it is quite possible that the producers would never be able to recover overpaid royalties on take-or-pay payments. 19 Diamond Shamrock, 853 F.2d at 1166 (footnotes omitted). If the Lease language and Louisiana law require Frey to share in take-or-pay payments, we could not hold otherwise simply because Amoco could have to send two checks to Frey instead of one if the market value of gas rises when Columbia takes it. 3 20 On the facts of this case, we reject the possibility that a drop in market demand and price between the time that a pipeline submits a take-or-pay payment and recoups the gas could necessitate a refund from the lessor who shares in take-or-pay payments. Columbia paid Amoco approximately $45.6 million as a recoupable take-or-pay payment under the Settlement Agreement and in exchange, was allowed to take $45.6 million worth of gas over five years. The Settlement Agreement establishes the price for each thousand cubic feet (MCF) of gas recouped by Columbia during this period, so here the volume of gas taken, not the price paid, varied with market price over the make-up period. Thus, no refund from Frey could have been necessary under the Settlement Agreement. 4 21 We notice another argument worth consideration, but not raised by Amoco. The words amount realized at the well from [gas] sales could indicate that Amoco and F & L understood that Amoco would pay royalties only on amounts it received for gas physically present at the well and that gas could only be present at the well during production. But, again, the Lease demonstrates that Amoco knew how to make royalties explicitly dependent on production but did not do so. Rather than inferring a production requirement from the Lease's at the well language, we interpret this term-of-art according to its received meaning in the oil and gas industry. Kavanaugh v. Berkett, 407 So.2d 645, 647 (La.1981); see also LA.CIV.CODE ANN. art. 2047 (West 1987) (Words of art and technical terms must be given their technical meaning when the contract involves a technical matter.). Before at the well became widely used in gas leases, Louisiana courts held that the value of gas was to be determined at the well absent a lease provision to the contrary. Sartor v. Arkansas Natural Gas Corp., 321 U.S. 620, 622, 64 S.Ct. 724, 726, 88 L.Ed. 967 (1944). Later, to allocate refining and transportation costs among the lessor and lessee, parties specified the place at which gas is to be valued for royalty purposes. See Merritt v. Southwestern Elec. Power Co., 499 So.2d 210, 214 (La.Ct.App.1986). When we questioned Amoco's counsel about the significance of the term at the well during oral argument, he did not contend that this language did anything other than allocate gas transportation and marketing costs between Amoco and F & L.