Opinion ID: 1859617
Heading Depth: 1
Heading Rank: 3

Heading: Production in Paying Quantities

Text: At the trial of this matter, Freedom bore the burden of showing that the earlier leases terminated due to lack of production. Perry v. Nicor Exploration, 293 Ark. 417, 738 S.W.2d 414 (1987). In other words, Freedom had to show the well ceased to produce in commercial paying quantities. Ross asserts Freedom failed to do this because the figures introduced into evidence by Freedom impermissibly included overhead as a cost, and therefore when subtracted from revenues produced by the well failed to show the actual production of the well under the habendum clause. Ross asserts the trial court erred in adding in costs that were not lifting costs, although they might be direct costs of operation. In Turner v. Reynolds Metals, Co., 290 Ark. 481, 721 S.W.2d 626 (1986), we considered whether a gas lease should be canceled due to failure to produce in paying quantities. Turner, supra, at 482, 721 S.W.2d 626. We stated, A provision in a habendum clause of an oil and gas lease requiring production, as in this lease, means production in paying quantities. Turner, supra, at 483, 721 S.W.2d 626. In McLeon v. Wells, 207 Ark. 303, 180 S.W.2d 325 (1944), we held the phrase, and as long thereafter as oil or gas, or either of them, is produced from said lands by lessee, meant production in commercial quantities. . . . McLeon, supra, at 305, 180 S.W.2d 325. Commercial or paying quantities, we have said, is determined by what is profitable to the lessee. Turner, supra, at 483, 721 S.W.2d 626. [1] Ross, based upon dicta contained in Perry , asserts this court has adopted a lifting costs test. The sentence Ross relies on states, Cross-examination, however, revealed that he did not know if some of the expenses used in his calculations were directly related to lifting. Perry, supra, at 421, 738 S.W.2d 414. Ross also cites Mason v. Ladd Petroleum Corp., 630 P.2d 1283 (Okla.1981), as support, wherein the Oklahoma Supreme Court stated, Only those expenses which are directly related to lifting or producing operations can be offset against production proceeds to determine whether a well is a producer. We have not expressly adopted this test nor have we explicitly decided what is meant by costs directly related to lifting. Other jurisdictions have dealt with this question. The Oklahoma Supreme Court in Stewart v. Amerada Hess Corp., 604 P.2d 854 (1979), defined lifting expenses as Expenses necessary to lift the oil from the ground. The Oklahoma Supreme Court also stated, The term `lifting costs' relates to a portion of the cost of producing oil and gas exclusive of drilling and equipping coststhe term defies a more precise definition. Hininger v. Kaiser, 738 P.2d 137 (Okl.1987). The Supreme Court of Kansas seems to be in agreement that costs of drilling and equipping the well are excluded. Texaco, Inc. v. Fox, 228 Kan. 589, 618 P.2d 844 (1980). This is also true in Texas. See Evans v. Gulf Oil Corp., 840 S.W.2d 500 (1992). In Reese Enterprises, Inc. v. Lawson, 220 Kan. 300, 553 P.2d 885 (1976), the Kansas Supreme Court stated, Expenses which are taken into account in determining `paying quantities,' include current costs of operation in producing and marketing the oil or gas. The crucial issue, then, is whether the well, when appropriate expenses are deducted, turns a profit, however small. Costs of drilling and equipping the well are excluded, because they are not costs of operation of the well. In Kansas, marketing is a cost of operation, and apparently is often added in because without it there is no production. Reese Enterprises, Inc., supra . Depreciation has been included as a cost of operation by some courts, but the better view is to exclude it as associated with the equipping of the well. Williams & Meyers, Oil and Gas Law § 604.6(b). Overhead is excluded by some courts as a cost. We agree with the view that what ought to be considered are direct expenses attributable to the operation of the lease. Reese Enterprises, Inc., supra . The trial court examined the accounting data put forth by the parties. He then relied upon the chart prepared by Ross using figures from Sonat's joint-interest billing statements. According to Ross's president, Tim Smith, the chart employed the cost figures furnished by Sonat less the following items that Ross contended should not be counted as direct operating costs: (1) administrative overhead; (2) other; (3) equipment rentals other than compressors; (4) environmental safety; (5) meals; (6) communication; (7) miscellaneous; (8) entertainment; and (9) allocated costs. The remaining costs included in Ross's chart are: Pumping labor; field labor; auto/truck; road/location; chemical treating; taxes; salt water disposal; product/equipment services; well services; services for leased equipment; other and indirect services; and materials and supplies. These expenses are in accord with those set out by the Kansas Supreme Court in Reese, supra . Based upon Ross's figures, the trial court found that for the twenty-four-month period preceding April 30, 1996, the well was operated at a net loss. Consequently, it did not produce in commercial paying quantities and the leases terminated under their own terms. Appellant has not shown that the trial court considered improper costs in deciding the well's lack of profitability. Ross asserts the Joint Interest in Billing Statements and the Profit and Loss Statements do not provide information from which one can determine the lifting or direct costs of production. Ross asserts the categories listed on the statements did not provide information about what exactly was included. Ross also asserts that their Exhibit N-10 was misunderstood by the trial court as representing what Ross believed the lifting/direct costs to be, when it was actually only a statement created with the categories removed that were clearly inapplicable as overhead, but the remaining categories are still unreliable because without actual invoices, it is impossible to determine the accuracy of what was charged to the operation of the well. The trial court found that Sonat maintains a computerized accounting system. Each Sonat operated well is assigned a property number. Revenues and expenses are then coded with the property number of well to which they pertain as they are entered into the accounting system's computer. The trial court also noted that the accounting information is used to bill non-operating lease holders and to generate the profit and loss statements. The evidence of costs came in by expert and lay testimony. The judge has broad discretion in admitting expert testimony. Scott v. State, 318 Ark. 747, 888 S.W.2d 628 (1994). And, as to credibility, We have held many times that this Court will defer to the trial court's evaluation of the credibility of the witnesses. Saforo & Assoc. Inc. v. Porocel Corp., 337 Ark. 553, 991 S.W.2d 117 (1999)(quoting Crawford v. Dep't of Human Services, 330 Ark. 152, 951 S.W.2d 310 (1997)). The costs considered appear to be those reasonably associated with producing gas from the well. We hold, therefore, that the chancellor did not clearly err.