Opinion ID: 2575852
Heading Depth: 1
Heading Rank: 4

Heading: Method to Determine Gross Value of the Production of Gas for Gross Production and Petroleum Excise Taxes

Text: ¶ 18 The price paid for the purchase of gas at the wellhead in an arm's length transaction between the producer and the purchaser is the standard on which gross production taxes must be computed. Apache Gas Products Corp. v. Oklahoma Tax Commission, 1973 OK 34, 509 P.2d 109. When the first arm's length sale occurs after processing, the OTC utilizes two methods to value the gas production: 1) gross proceeds received by the producer from the first arm's length sale of the residue gas, the liquid hydrocarbons and the drip condensate less the allowable expenses, or 2) the price received for the residue gas multiplied by the wellhead MMBTU (wellhead measurement of volume and heating content) less the allowable expenses. ¶ 19 The OTC contends these are valid methods for calculating the tax under 68 O.S.2001, § 1001 and its administrative rules. Texaco, on the other hand, urges that the prevailing price is the valid method under 68 O.S.2001, § 1009(f). Texaco argues that the prevailing price method utilizes wellhead values paid under arm's length contracts with other producers for the sale of unprocessed gas at the wellhead in the same field and results in a calculation of the severance tax on Texaco's gas production the same as on other producers. The OTC argues that the prevailing price provisions in § 1009(f) were intended to protect state revenue where the producer and purchaser enter into a sweetheart contract to sell the gas for less than the prevailing price and are not applicable to the facts in this case. ¶ 20 Sections 1001, 1009 and 1010 of the gross production statutes deal with the value of gas in comprehensive terms. These statutes 1) impose the tax upon the severance of gas at the rate of seven percent of the gross value of the production of gas, § 1001(B)(4); 2) require the reporting of the total value of the mineral oil, gas, or casinghead gas, at the time and place of production, including any and all premiums paid for the sale thereof, at the price paid, at the time of production, § 1010(B)(5); and 3) permit the OTC to require the tax to be paid upon the basis of the prevailing price if the gas is sold under circumstances where the sale price does not represent the cash price prevailing for gas of like kind, character or quality in the field, § 1009(f). (Bold added.) ¶ 21 In considering these statutes, Texaco urges us to follow Oklahoma Tax Commission v. Sun, 1971 OK 100, 489 P.2d 1078. That case concerned gas purchased at the wellhead subject to the producer's right to process the gas. The OTC assessed additional gross production taxes on the net price the producers received for the extracted liquid hydrocarbons. The Sun decision turned on the statutory language imposing the tax at the time and place of production in § 1001. Id., 1971 OK 100, at ¶ 12, 489 P.2d at 1081. It did not construe the statutory provisions applicable herein. ¶ 22 Both parties rely on Apache Gas Products Corp. v. Oklahoma Tax Commission, supra . Apache construed the prevailing price provisions in § 1009(f). Apache involved the sale of low pressure gas under a wellhead purchase contract. The OTC assessed additional taxes based on a countywide prevailing price. The trial court found that the gas purchase contract was an arm's length transaction and the price paid for the gas was the highest and best in the field; however, the trial court concluded that the OTC was not bound by that price but was authorized to fix gross value based on the prevailing price. In overturning the trial court, Apache reasoned that the gross production tax statutes do not contemplate that the purchaser will pay the producer one price and deduct the gross production tax from that price but then report and pay the tax based on another price. Apache Gas Products Corp. v. Oklahoma Tax Commission, 1973 OK 34, at ¶ 16, 509 P.2d at 113. ¶ 23 Ruling against the OTC, Apache also provided guidance for future applications of § 1009(f). The OTC should calculate the gross production tax on the gross proceeds realized by each producer from his individual sales contracts unless the contract is not a reasonably prudent exercise of arm's length bargaining; and where the contract does not reflect arm's length bargaining, the OTC should calculate the tax on the prevailing price in the field at the time of production. Apache Gas Products Corp. v. Oklahoma Tax Commission, 1973 OK 34, at ¶ 27, 509 P.2d at 116. Apache said the field, to be determined in each case, should be equated with the common source of supply as that term is understood in the industry. Id. ¶ 24 Although Apache is distinguishable on the facts, its reasoning supports application of Howell v. Texaco, Inc., 2004 OK 92, 112 P.3d 1154, in this case. Royalty owners of gas produced and processed by Texaco in Stephens County initiated the suit in Howell v. Texaco, Inc . Howell decided, for purposes of royalty payments, what is the appropriate method for determining market value of gas at the wellhead if the first arm's length sale occurs after the gas has been processed. ¶ 25 Howell recognized three methods of establishing market value at the wellhead: 1) the actual sale price paid through arm's length negotiation; and, in the absence of an arm's length wellhead purchase, 2) the prevailing market value method, and 3) the work-back method whereby the market value at the wellhead is calculated by subtracting allowable costs and expenses from the proceeds of the first downstream, arm's length sale. Id., 2004 OK 92, at ¶¶ 18-20, 112 P.3d 1154. Howell concluded that in the absence of an arm's length wellhead purchase, the royalty payments must be calculated on the prevailing market price or the work-back method whichever one is higher. Id., 2004 OK 92, at ¶ 22, 112 P.3d 1154. Howell also concluded that the proceeds from the components of the gas are considered in the workback method. Id., 2004 OK 92, at ¶ 22, 112 P.3d 1154. ¶ 26 The methods for establishing wellhead value in Howell fall within the comprehensive language used in the pertinent gross production tax statutes-gross value in § 1001(B)(4); total value including any and all premiums in § 1010(B)(5); and prevailing price in § 1009(f). The OTC already effectively utilizes these methods in the administrative assessment process when it calculates 1) the gross proceeds received by the producer from the first arm's length sale of the residue gas, the liquid hydrocarbons and the drip condensate less the allowable expenses or 2) the prevailing price under Apache. And, other provisions in these statutes contemplate that the purchaser will report and pay the gross production tax based on the price it paid to the producer and the royalty owners. [6] Accordingly, we hold that in the absence of an actual arm's length sale at the wellhead, gross value of gas for calculation of gross production taxes is to be determined by using the prevailing price method or the work-back method adopted in Howell v. Texaco, Inc., 2004 OK 92, 112 P.3d 1154, whichever results in the higher value. We further hold that Texaco's purported contract with itself to purchase its own gas at the wellhead cannot be the basis to establish value of gas for calculating gross production taxes.