Opinion ID: 410950
Heading Depth: 1
Heading Rank: 2

Heading: What is Market Value?

Text: 10 In determining market value under these Texas leases, the familiar willing-buyer, willing-seller method of establishing comparative market prices is somewhat distorted by the federal price controls. Until 1978, the Federal Power Commission (FPC) regulated by orders the price of natural gas in interstate commerce. 2 The Natural Gas Policy Act of 1978, 15 U.S.C. Secs. 3301, et seq., established the Federal Energy Regulatory Commission (FERC), which has authority to impose varying maximum price ceilings on both intrastate and interstate gas. The FERC categorizes the gas according to its physical characteristics, vintage from the geographic location and the date the well was dug, and when and what market it was committed to sale, and fixes varying maximum ceiling prices within the different categories for sale by the producer to distributors. The FPC (and now, the FERC) lacks authority to regulate the amount of royalty paid by the lessee-producer to the lessor, see Mobil Oil Corporation v. Federal Power Commission, 463 F.2d 256 (D.C.Cir.), cert. denied, 406 U.S. 976, 92 S.Ct. 2409, 32 L.Ed.2d 676 (1971); however, since the plaintiffs' royalties are based on a percentage of the market value of the gas when sold, federal regulation of price implicitly affects the amount of royalties based upon the market value of the natural gas produced and sold by the lessee.
11 Texas law has sought to preserve the willing-buyer, willing-seller concept of market value by basing it on comparable sales of similar gas. The Texas Supreme Court holds that market value of gas is to be determined at the time the gas is produced rather than when the producer and distributor execute a long-term contract. It is sold for purposes of the royalty provision at the time of each delivery to the pipeline; the lessor is entitled to royalties based on the value of comparable, contemporaneous sales of gas and not merely the proceeds from the producer's sales contract. See Texas Oil & Gas Corporation v. Vela, 429 S.W.2d 866 (Tex.1968). 12 Similarly, in Exxon Corporation v. Middleton, 613 S.W.2d 240 (Tex.1981), the Texas Supreme Court considered the gas sold at the time of delivery, regardless of the fixed price to which it has been committed in a long-term contract, and found that gas should be valued as though it is free and available for sale. 613 S.W.2d at 246 (emphasis supplied). The lessor may calculate the current market value of gas production by using evidence of comparable sales, defined as those sales comparable in time, quality, quantity, and availability of marketing outlets. 613 S.W.2d at 246 (citing Vela ). 13 The Middleton decision defined comparability of sales, however, to reflect the regulation of market prices of natural gas. Comparability of quality means not only similar physical properties, but also includes the legal characteristics of the gas: whether it is sold in a regulated or unregulated market, or in one particular category of a regulated market. Id. (emphasis supplied). In defining comparable marketing outlets, the court pointed to both geographic location and legal markets, for [g]as from fields with outlets to interstate markets only, for instance, would not be comparable to gas from a field with outlets only to the intrastate market. Id. at 247. 14 Vela and Middleton involved only sales of unregulated gas sold in the intrastate market. However, Middleton's holding that the market value of intrastate gas could not be determined by the non-comparable sales of regulated interstate gas--and its reference to comparability as including not only the legal characteristic of whether the gas is sold in a regulated or an unregulated market, but also whether in one particular category of a regulated market--at least implicitly support equally the rationales: (a), that the sales of unregulated, intrastate gas cannot be comparables upon which to fix the market value of gas dedicated to the regulated interstate market (as specifically held by the Texas court a few months later in First National Bank in Weatherford v. Exxon Corporation, 622 S.W.2d 80, 81-82 (Tex.1981)), and also (b), pertinently here, that the sales of gas in one regulated category are not comparables to be utilized in fixing the market value of natural gas sold in another regulated category. 15 The Fifth Circuit has also recognized that the determination of market value must consider the price regulation of the market in which the gas may legally be sold. In Kingery v. Continental Oil Company, 626 F.2d 1261, 1264 (5th Cir. 1980), cert. denied sub nom. Brent v. Natural Gas Pipeline Co. of America, --- U.S. ----, 102 S.Ct. 1012, 71 L.Ed.2d 302 (1982), which was rendered after the Texas appeals court, but before the Texas Supreme Court decided Middleton, 3 this court held that because sellers and buyers of gas in interstate commerce cannot lawfully contract for prices above federal ceilings, sales on the unregulated intrastate market are not comparable in calculating the market value of gas committed by producer contract to interstate commerce. 626 F.2d at 1264-65. This court reaffirmed that the test for market value is: 16 [W]hat ... a willing seller and a willing buyer in a business which subjects them and the commodity to restriction and regulation, ... [would] agree to take and pay with a reasonable expectation that the FPC [now the FERC] would approve the price (and price changes) and other terms and then issue the necessary certificate of public convenience and necessity. 17 Kingery, 626 F.2d at 1264. 18 The plaintiffs Bowers point out that Kingery and Weatherford held only that sales of un regulated gas could not be regarded as comparables to determine the market value of regulated gas, and that Middleton held only that sales of regulated gas were not comparables for determination of the market value of unregulated gas; the decisions did not expressly hold that comparables of sales of regulated gas did not include all sales within the regulated market. Bowers further notes that these decisions did not disturb the basic holding of Vela that the market value for purposes of calculating royalties is not determined by the price fixed in the long-term contract between the producer and the distributor, but rather by the current market value of the gas produced, nor did any of these decisions disturb the Texas rule that the gas should be valued as though it is free and available for sale. Middleton, supra, 613 S.W.2d at 246. 19 Nevertheless, in its decision in Weatherford, citing the result in the Fifth Circuit's Kingery with approval, 622 S.W.2d at 80 n. 1, the Texas Supreme Court reiterated the Middleton enunciation of the determination of market value, 613 S.W.2d at 247, by using only comparables with the same legal characteristics of the natural gas in question, such as sales in one particular category of a regulated market ... with marketing outlets similar to the gas in question. Weatherford, supra, 622 S.W.2d at 81. This rationale, in our opinion, requires us, Erie -bound by Texas law, to reject Bowers' contention that the market value of regulated, interstate-dedicated natural gas shall be determined by treating the present gas production as though it was newly produced or otherwise available for higher price and thus free of the particular federal price-fixed category into which it falls because of the preexisting long-term contract. 20 Fuller reference to the federal regulatory scheme is now required, in order to explain our conclusion that the market value of natural gas produced under a long-term contract and dedicated to interstate use is fixed by the maximum allowable price for regulated gas of the same particular category, and that this is consonant with the pronouncements in Vela and Middleton that the market value is determined as though the gas were free of the contract and available for sale in the current market and not bound to the actual price paid under the long-term sales contract.
21 The district court found that Phillips had at all times during gas production paid Bowers royalties based on the maximum lawful ceiling prices that could be charged for the gas from that geographic area that had been committed to interstate commerce under a long-term contract. 4 Bowers contends that if the gas were not committed to the long-term contract between Phillips and Natural; that is, treated as though it is free and available for sale, Middleton, supra, 613 S.W.2d at 246, in the regulated market, the gas could command a higher price under federal law than the proceeds actually received from Phillips' sales to Natural under its long-term contract. For proof of comparable prices for free and available interstate gas, Bowers points to the maximum price ceilings imposed by the Natural Gas Policy Act on renewal, or rollover, contracts between a producer and an interstate distributor, which permit higher prices to be charged for the gas than do the ceilings for gas sales contracts that have not expired by their own terms. Phillips, of course, maintains that interstate rollover gas sales from renewal contracts constitute a separate category under the Act, and thus are not comparable to interstate gas sales from existing contracts (a different category), such as the Phillips sales contract that formed the basis of royalties paid by Phillips to Bowers. 22 The Natural Gas Policy Act authorizes the FERC to implement maximum price ceilings for different categories of gas produced in the United States. The Act sets forth gas categories based on the timing of drilling, location of wells, and markets for gas, with resultant variations in the maximum lawful price of first sales of the gas from that particular source. 5 The gas produced from Phillips' wells and sold to Natural is regulated by 15 U.S.C. Sec. 3314, which provides for maximum price ceilings for gas committed to interstate commerce on November 8, 1978. Section 3316, however, permits a different, higher, price ceiling for gas that was previously subject to an existing [interstate] contract which expired at the end of a fixed term ... whether or not there is an identity of parties or terms with those of the ... existing contract. Sec. 3301(12). In effect, the rollover provision requires that the gas retain its interstate status in subsequent sales, but permits it to be sold at a higher price than that of the prior interstate contract. See, e.g., 18 C.F.R. Sec. 271.101 (1981). 23 We cannot accept Bowers' contention that if the gas from its properties were free [of the contract] and available for sale, the market value of the gas from its properties would be the price of rollover gas or of new gas. In Middleton, the Texas Supreme Court has held that only sales of gas of comparable quality may be used to prove market value, taking into account its legal characteristics and whether it is sold in one particular category of the regulated market. Middleton, 613 S.W.2d at 246. The particular category of this gas is interstate gas under the maximum price ceilings of Sec. 3314, not the rollover provision of Sec. 3316, for there is no present lawful means by which the Phillips-Natural contract could expire by its own terms, as required by federal regulations, or could otherwise be renewed or replaced and be subject to a higher ceiling as rollover gas. 6 It would be as unlawful to market this gas as rollover gas, outside its particular category under the Act, as it would be to sell it as intrastate gas. 24 The requirement under Texas law that market value be calculated as though the gas were free and available for sale has content under this interpretation. The lessee must base the lessor's royalties on comparable sales of gas with the same legal characteristics and subject to the price restraints of the particular category of the Act, and not solely on the actual proceeds obtained under the sales contract it has with the distributor. If Phillips were receiving less than the maximum ceiling price from Natural, which is permitted under the Act, see 15 U.S.C. Sec. 3311(b)(9), 7 then Middleton's prescription that the gas should be considered free and available for sale would presumably permit Bowers to prove that comparable sales include existing interstate sales contracts that pay the maximum federal ceiling price.