Opinion ID: 543116
Heading Depth: 2
Heading Rank: 2

Heading: Plant Fuel.

Text: 94 The royalty owners contend that the district court erred in determining that Shell has fully paid the royalties due the royalty owners on the portion of the gas used as fuel to run the Thomasville plant. As the court explained in Piney Woods I, 539 F.Supp. at 963, 95 The cost of gas processing and sulphur recovery at the Thomasville Field, together with costs of gathering and transporting, are deducted by Shell in calculating payments to royalty interest owners for their respective interests in the subject gas. Similar charges are deducted pro rata from the working interest owners' shares of production. To compute these payments, Shell devised an allocation and accounting procedure which insures that each well is properly credited for its share of the production while reimbursing the plant for costs associated with processing the gas. This latter function is accomplished by equations which compute a 'plant-lease split' of the residue gas and sulphur revenues. [Footnote omitted.] 96 In Piney Woods II we held, 97 The leases plainly call for market value royalty on gas used off the lease and the royalty should be determined on that basis. We therefore hold the plant fuel is gas used off the lease and the lessors are entitled to market value royalty on that gas. Shell may, however, treat the royalty payments as processing costs to be divided, as any other processing costs, among the various working and royalty interests. 98 726 F.2d at 241. Our opinion concluded, We also hold that the plaintiffs are entitled to royalty on plant fuel, but Shell may include these royalties as processing costs. Id. at 242. 99 Shell claims that it owes the royalty owners nothing, as the royalty payments on plant fuel that would be due to them are exactly balanced by the share of the processing costs that are to be borne by the royalty owners. Shell asserts that its plant-lease split formula 19 is a conceptually proper allocation of costs and that when it is correctly applied, no net payments are due to the royalty owners. 100 To the extent that the formula allocates costs among the different wells, the royalty owners do not challenge the formula; rather, they dispute what should be included as costs originally. In particular, they claim that one of the formula's processing cost terms, that for treating plant operating cost per day, should include, for each well lease, only the cost of the royalties paid on the plant fuel, rather than including the cost of all of the plant fuel used. This is the crux of the dispute. 101 The royalty owners rely heavily upon the above-excerpted language from Piney Woods II, where we said that their leases entitle the royalty owners to royalty on plant fuel just as on other gas but that Shell may deduct these royalty payments as processing costs. The inescapable implication, the royalty owners assert, is that Shell may not deduct the value of all of the plant fuel as a processing cost, but instead may deduct as a processing cost only the royalty owners' contractual share of the market value of the gas used as plant fuel. 102 The royalty owners present evidence that industry custom and past accounting methods used in the instant case did not treat the plant fuel as a processing cost; they contend Shell's present stance that the value of all of the plant fuel should be included in the processing costs is an ad hoc accounting manipulation devised by Shell with the purpose of evading its responsibility under Piney Woods II to pay royalty on plant fuel. The royalty owners also note that Shell's minority working interest owners had specifically relinquished any right they might have to plant fuel gas. Therefore, the royalty owners are by contract differently situated from Shell's minority operating interest owners, and Piney Woods II unambiguously entitles the royalty owners to royalty payments from plant fuel, whereas the minority working interest owners are not entitled to any profit from that plant fuel. 103 In sum, the royalty owners make three points: (1) Piney Woods II held that they are entitled to royalty payments on plant fuel but that Shell could deduct such royalty payments from processing costs; (2) plant fuel as a whole customarily has not been treated as a processing cost; therefore, only those royalty payments made on the plant fuel are to be treated as processing costs; and (3) Shell's minority working interest owners have forfeited any right to plant fuel, whereas the royalty owners in fact have a right to some share of the value of the plant fuel. Therefore, the royalty owners assert, there is a contractual basis for the royalty owners' paying only their share of the costs of making royalty payments to them, not their proportionate royalty share of what would be the cost of all the plant fuel. The basis for this distinction is that it cannot be said that there is any cost to Shell either for the plant fuel that comes from the minority working interest owners (as they have freely agreed to forfeit that plant fuel) or for plant fuel that is already attributed to Shell. 104 These three contentions, if taken as true, would at first appear to lead inexorably to the conclusion that the royalty owners should pay for processing costs that arise from the use of plant fuel only to the extent that the revenue base from which they take their royalty share is reduced by the cost of royalty payments made on the value of plant fuel, rather than being reduced by the full value of the plant fuel. The royalty owners' beguiling argument must ultimately fail, however. Logic and equity dictate that all of the plant fuel value is a processing cost; none of this fuel survives to be marketed by any of the working interest owners; by definition, it is all used to facilitate the production of the gas that is sold. Indeed, as explained in Piney Woods I, royalty is obligated to contribute proportionately to the costs of processing the product, 539 F.Supp. at 971, and the only equitable conclusion is to hold that lessor and lessee shall bear proportionately costs of materially enhancing the value of the subject gas. Id. at 973. Undeniably, all of the plant fuel contributes to the material enhancement of the value of the gas sold. 105 More importantly, in Piney Woods II we held, On royalties 'at the well', therefore, the lessors may be charged with processing costs, by which we mean all expenses, subsequent to production, relating to the processing, transportation, and marketing of gas and sulfur. 726 F.2d at 240. Plant fuel is certainly an expense; the fuel to operate the plant is valuable gas that, but for its use in operating the plant, would be sold along with the rest of the gas produced. 106 The fact that Shell in the past has not included any charges for plant fuel in its list of processing costs does not imply that plant fuel is not a processing cost. Because the gas used as plant fuel comes directly from the pool of gas that would otherwise be sold, plant fuel is unlike other cost components of producing the gas. Plant fuel is produced and consumed in the process. Because Shell must pay cash for them, other cost components must be itemized and later deducted from sales revenues; plant fuel, on the other hand, is simply deducted directly from the supply of gas to be sold. Thus it is not surprising that plant fuel was never previously included in the equation used to compute processing costs. 107 For other processing costs, the royalty owners bear their royalty share of the charges and participate in the resulting enhancement to the value of the final product in proportion to their royalty share. The royalty owners' entitlement to their royalty share of the plant fuel was always precisely equal to their obligation to pay their royalty share of this processing cost. For the other processing costs, the royalty owners had no entitlement to a share of these materials, so it was necessary for them to pay from sale proceeds. 108 The fact that we found in Piney Woods II that plant fuel was gas used off the lease, id. at 241, and thus, by the terms of their contract, royalty owners were entitled to royalties on that fuel, does not by itself imply that the royalty owners are entitled to any net gain as a result. The royalty agreement of course never said that the royalty owners were not entitled to royalties on plant fuel; Piney Woods II did not alter the legal relationship between the parties on this issue. 109 Quite simply, under the terms of the royalty agreement, because plant fuel is gas used off the lease, the royalty owners are entitled to a royalty share on this gas, and because the plant fuel materially enhances the value of the gas (giving the royalty owners more than the at-the-well value for which they bargained), the cost of plant fuel must be borne by the royalty owners in proportion to their royalty share. Hence, because we find plant fuel is a processing cost, we read our Piney Woods II decision as merely ratifying as correct the existing course of performance on the royalty contract; no further payments are due to the royalty owners. 110 The royalty owners finally argue that treating plant fuel as a processing cost is to imply that payments were being made to Shell and minority working interest owners for years with no record of such. In fact, constructive payments of plant fuel were made in the sense that the fuel would have been divided between royalty owners and working interest owners had it not been needed to run the plant, and thus the working interest owners are foregoing what would be theirs in order to satisfy the conditions of the contract about running the plant. We view the minority working interests' forfeiture of their right to plant fuel as merely an explicit recognition of this situation. Thus, we affirm the district court's determination on the plant fuel issue. 111