Opinion ID: 1265995
Heading Depth: 1
Heading Rank: 1

Heading: Background; The Primary Issue

Text: This case is closely parallel to Waechter v. Amoco Production Co., 217 Kan. 489, 537 P.2d 228 (June 14, 1975), adhered to after rehearing, 219 Kan. 41, 546 P.2d 1320 (March 6, 1976). In each case the basic claim of the plaintiff royalty owners was that under their leases they were entitled to have their royalties computed on the market value at the wellhead of the gas taken by the producer. That market value, they asserted, was to be determined by the traditional free market, willing buyer-willing seller test, without regard to any governmental regulation of the producer's sales price. The producers, on the other hand (Amoco there, Mobil here) relied on the fact that their sales at the wellhead were for resale in interstate commerce, and their sales prices were thus subject to Federal Power Commission regulation under the Natural Gas Act of 1938, 15 U.S.C. § 717 et seq. (That principle was established June 7, 1954, by Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 98 L.Ed. 1035, 74 S.Ct. 794.) The result, they claimed, was that the market value of the gas they sold was the ceiling price fixed by the FPC. The determination of the primary issue in both cases was delayed for several years by a federal injunction staying the state cases while the producers, along with other producers, conducted the litigation resulting in Mobil Oil Corporation v. Federal Power Commission, 463 F.2d 256 (D.C. Cir.1972), cert. den. 406 U.S. 976, 32 L.Ed.2d 676, 92 S.Ct. 2409. That case held that a royalty owner is not a natural gas company as defined in the Natural Gas Act because he does not engage in the sale of gas in interstate commerce. Hence the FPC has no jurisdiction over a royalty owner or over a dispute between a royalty owner and his producer as to the amount of royalties payable under a gas lease. Once Mobil had been decided and review by the United States Supreme Court had been denied, the state litigation was allowed to proceed. The district courts in both Waechter and this case concluded that the plaintiff royalty owners were entitled to be paid on the basis of an unregulated market value. The producers in each case had committed their entire production to the interstate market under long term contracts. In Waechter the 1950 contract between the producer Amoco (then called Pan American Petroleum Corp.) and the purchaser Cities Service called for a fixed price until June 23, 1961, and thereafter for a fair and reasonable price for each successive five year period, based on the going price in the field. When the parties were unable to agree the price was settled by a declaratory judgment action, affirmed in Pan American Petroleum Corporation v. Cities Service Gas Co., 191 Kan. 511, 382 P.2d 645. The amount fixed in that case was employed by the district court in Waechter as the market value of the gas. In this case there were two contracts between the predecessor of the producer Mobil and its pipeline purchaser, Northern Natural Gas Company, called the A and B contracts. Both called for fixed prices until July 1, 1958, and for each five year period thereafter the fair, just and reasonable price for gas produced in the field. These contracts called for arbitration in the event of disagreement, and as a result arbitrators fixed a fair, just and reasonable price for the gas sold under the contracts for the five year period here in issue. Neither the royalty owners nor Mobil offered any independent evidence on the issue of market value, as they might have. (See Lippert v. Angle, 211 Kan. 695, 508 P.2d 920.) As a result the district court in this case employed the arbitrated prices as the market value under the leases in the same way the judicially fixed price was employed in Waechter. In both cases the producers submitted the proposed new rates (the one determined by suit, the other by arbitration) to the FPC for approval. Neither rate was approved as filed, but both were ultimately adjusted downward. In both cases the royalty owners sought the difference between the royalties paid on the rates ultimately approved, received and lawfully retained by the producers from their purchasers, and the royalties they would have received if the FPC had approved the new rates based on the market value of the gas. In both cases the district courts construed the royalty clauses in the leases to require royalties based on an unregulated market value, found no constitutional impediment to requiring payment on that basis, and rendered judgment for the plaintiff royalty owners accordingly. In Waechter we reversed on this issue, based on a contrary construction of the prototype royalty clause by which all members of the plaintiff class had agreed to be bound. We found that it called for royalties based on the proceeds received by the producer, and not on the market value of the gas. We observed that Proceeds ordinarily refer to the money obtained by an actual sale. (217 Kan. at 512.) Since royalties had been paid on the proceeds of all of Amoco's sales to Cities, the royalty owners were not entitled to any additional royalties. Under that reasoning the court was not called upon in Waechter to construe the term market value, or to determine how it might be affected by FPC regulation. In this case, however, we are confronted with several different forms of lease, some of which indisputably call for royalties based on market price or market value. (The majority, and the trial court, make no distinction between those terms but use them interchangeably. Both are construed to mean what the product will bring in the marketplace, without regard to any element of inherent value.) It is therefore necessary in this case to determine whether market value (or market price) means value in a hypothetical free market, or value in the interstate market as limited by FPC regulation.