Court Opinion

ID: 9617817
Source: CourtListenerOpinion
Date Created: 2023-08-22 05:01:48.309797+00
Date Added: 2024-06-11T18:04:17.755577
License: Public Domain

Justice ERICKSON
specially concurring:
I specially concur in the result reached by the majority. The following question of law was certified to this court in accordance with C.A.R. 21.1 by the United States District Court for the District of Colorado:
Under Colorado law, is the owner of an overriding royalty interest in gas production required to bear a proportionate share of post-production costs, such as processing, transportation, and compression, when the assignment creating the overriding royalty interest is silent as to how post-production costs are to be borne?
The answer to the certified question is no. The order of certification includes a stipulation stating facts relevant to the certified question and the controverted issue. Our answer to the certified question should be limited by the record and the question of law certified for determination.
The federal oil and gas leases that were assigned to Conoco were burdened by the overriding royalty interest held by the Gar-mans. The assignment to the Garmans reserved an overriding royalty interest that was to be paid on “all oil, gas, and casinghead *662gas produced from the Conoco leases.” By stipulation, Conoco and the Garmans agreed:
The phrase “produced, saved and marketed” as it is used with respect to the payment of royalties and overriding royalties means that royalties are only paid on the production that is actually marketed, so that no royalties and overriding royalties are paid on production that is unavoidably lost or used for operating, development, and production on the lease.
When gas was first produced, Monarch Enterprises, Inc., Conoco’s predecessor in interest, executed a division order, which provided: “ ‘the proceeds shall be calculated both as to price and quantity on the basis of and in the manner provided for’ in the contract dated May 10, 1963 between Continental Oil Co. and Western Slope Gas Co.”
In 1982, Conoco prepared an oil and gas transfer order, which Monarch Enterprises, Inc. signed. The oil and gas transfer order stated:
Settlement for gas sold shall be based on the net proceeds realized at the well by you [Conoco], after deducting any costs incurred in compressing, treating, transporting and/or dehydrating the’gas for delivery. If the gas is processed in or near the field where produced, settlement shall be based on the net proceeds realized at the well, as determined by the agreement between the producer and processor, or, in the absence of such an agreement, the same basis as settlement with other producers of gas of like kind and quality processed at the same plant.
In October 1992, Conoco sent the Garmans a confirmation of interest which they signed after deleting the three paragraphs relating to the apportionment of costs. The transfer order, signed by the Garmans’ predecessor in interest and quoted above, was stricken from the confirmation of interest signed by the Garmans. The gas at issue is delivered by Conoco to the Dragon Trail Processing Plant. The processing plant produces three marketable products from the gas: (1) residue gas, (2) propane, and (3) butane gasoline. Conoco contends that extracting propane and butane gasoline enhances the overall value of the gas and that production charge to the Garmans is largely tied to the processing plant. The Garmans, however, contend that the activities in the processing plant, which include compression and dehydration, are necessary to make the gas marketable.
The Garmans filed a declaratory judgment action in the federal district court to determine whether Conoco had the right to apportion production costs and withhold costs under the 1982 transfer order when the assignment of their overriding royalty interest did not provide for the apportionment of costs. The Garmans assert that Conoco has not accounted for or paid the royalty that is owed to them as holders of an overriding royalty.
I
The working interest in a federal oil and gas lease was assigned to Conoco. An assignment of an overriding royalty interest was made to the Garmans prior to the time Conoco obtained its working interest. The certified question requests that we determine whether the Garmans, as owners of an overriding royalty interest in gas production, must bear a share of post-production costs incurred by Conoco, when there is no language in the lease or assignment as to who should bear the post-production costs.
The language contained in the lease and' the assignment of an overriding royalty provide the foundation for analysis of the certified question. The second step in our analysis requires us to determine whether the costs Conoco seeks to charge to the Garmans enhanced the value of the gas produced beyond an originally marketable condition or have merely made the gas marketable in the first place. Of key importance are the terms of the federal leases and royalty interests, and the nature of the claimed deductible items. See W.W. Allen, Annotation, Expenses and Taxes Deductible by Lessee in Computing Lessor’s Oil and Gas Royalty or Other Return, 73 A.L.R.2d 1056, 1057-58 (1960). The record before us does not contain facts that provide a basis for determining whether transportation includes gathering or whether compression is necessary to make the gas marketable.
*663“Post-production costs” is not a well-defined term. The leases in issue are federal leases and the deduction of production costs in the payment of the federal royalty interests is found in section 110 of the Natural Gas Policy Act of 1978, which provides that “production related costs are any costs of compressing, gathering, processing, treating, liquefying, or transporting ... natural gas or other similar costs, borne by the [lessee], ...” 15 U.S.C. § 3320(a) (1978). Production related costs cannot be deducted by the lessee in the calculation of royalties due the federal government. Mesa Operating Ltd. Partnership v. United States Dep’t of Interior, 931 F.2d 318 (5th Cir.1991). Neither the leases nor the overriding royalty assignment to the Garmans specify that production costs are to be apportioned. In answering the question, our inquiry requires that we define “overriding royalty interest.”
A
An overriding royalty interest in gas production is an “interest severed out of the working interest or lessee’s share of the oil, not to be charged with any of the cost or expense of development or operation.” Hagood v. Heckers, 182 Colo. 337, 347, 513 P.2d 208, 214 (1973); see also 8 Howard R. Williams & Charles J. Meyers, Oil and Gas Law 859 (1993) (An overriding royalty interest is “[a]n interest in oil and gas produced at the surface, free of the expense of production, and in addition to the usual landowner’s royalty reserved to the lessor in an oil and gas lease.”) (hereinafter Williams & Meyers). Overriding royalty interests are non-cost-bearing interests. Richard W. Hemingway, The Law of Oil and Gas 637 (3d ed. 1991).
Costs that enhance the value and .are necessary to sell the gas, such as processing, transporting, or compressing, occur after the gas is separated from the gas well. The cost of processing, transporting, or compressing the gas produced from the well may be allocated by agreement or contract. See, e.g., Magnetic Copy Serv. v. Seismic Specialist, Inc., 805 P.2d 1161, 1163 (Colo.App.1990).
Oil and gas leases in Colorado uniformly contain an implied covenant to market the gas produced by the lessee. Davis v. Cram-er, 808 P.2d 358, 361 (Colo.1991). The covenant to market requires a lessee to exercise reasonable diligence to market production from the well. Id. at 363. Under a covenant to market gas, the lessee has “a duty to get the product to the place of sale in marketable form.” Wood v. TXO Prod. Corp., 854 P.2d 880, 882 (Okla.1992). See California Co. v. Udall, 296 F.2d 384 (D.C.Cir.1961) (expenses to make the gas of pipeline quality not deductible); California Co. v. Seaton, 187 F.Supp. 445 (D.D.C.1960) (expense of gathering, compressing, and dehydrating to make the gas marketable not deductible); Hanna Oil & Gas Co. v. Taylor, 297 Ark. 80, 759 S.W.2d 563 (1988) (compression necessary to make the gas marketable not deductible); Schupbach v. Continental Oil Co., 193 Kan. 401, 394 P.2d 1 (1964) (same); Warfield Natural Gas Co. v. Allen, 261 Ky. 840, 88 S.W.2d 989, 991 (1935) (the lessee has the exclusive right to produce gas and find a market, and pays the expenses of doing both as consideration for its seven-eights of the production); West v. Alpar Resources, Inc., 298 N.W.2d 484 (N.D.1980) (expenses of an amine plant to extract hydrogen sulfide and other expenses necessary to make the gas marketable not deductible). Gas that is in marketable form is sufficiently free from impurities that it will be accepted by a purchaser. 8 Williams & Meyers at 692.
If the royalty clause is silent as to the condition and place of delivery of gas:
consideration should be given to the nature of the operation for which the expense is incurred and to the question of which party has the duty to perform such operation. If the operation is required to obtain a marketable product, it should be treated as an expense of operation to be borne by the lessee.
3 Eugene Kuntz, A Treatise on the Law of Oil and Gas 387-88 (1989). Absent the ability to discern a specific intent of the parties, Kuntz states:
Rather than resembling a sharing of profits, the payment made to the lessor by the lessee more closely resembles an expense which the lessee must incur in conducting the intended operation. A consideration of such fundamental nature of the arrange*664ment, together with a consideration of the rule of construction of the lease against the lessee, leads to the conclusion that any doubt with respect to placing the burden of any item of expense should be resolved against the lessee and in favor of the lessor.
Id. at 388.
II
Overriding royalty interest owners defer to the risk-bearing working interest to determine when and where a well is drilled, the formations to be tested, and whether to complete a well and establish production. The risk-bearing parties are responsible for the drilling and operation of the lease, and bear the costs of production. Owners of overriding royalty interests have no input into decisions involving costs. If the owner of an overriding royalty interest was responsible for post-production costs absent express language in the lease or assignment, the owner would be sharing the burdens of the risk-bearing owners without the corresponding right to a larger share of the proceeds for assuming a production cost. See Wood 854 P.2d at 883.
The parties to an oil and gas lease may, by express agreement in the lease, limit the covenants implied in the lease. The Supreme Court of Oklahoma stated, “If a lessee wants royalty owners to share in compression costs, that can be spelled-out in the oil and gas lease. Then, a royalty owner can make an informed economic decision whether to enter into the oil and gas lease or whether to participate as a working interest owner.” Id.
Because the certified question refers to the assignment creating the overriding royalty interest, it is necessary to examine the exact language of the assignment. The lease contains three clauses relevant to the calculation of the royalty:
Subject to certain hereinafter set forth conditions, Assignor reserves and Assignee does hereby agree to pay to Assignor on or before the 20th day of each month a sum representing four (4) per cent of the market value, as hereinafter determined, of all oil, gas, and casinghead gas produced, saved and marketed from any of the above described lands by Assignee under said above described lease.
Said overriding royalty shall be computed and paid on the basis of the market price for oil, gas and casinghead gas prevailing in the field where produced for oil, gas and casinghead gas of like quality, provided that no overriding royalty shall be paid or shall accrue upon any oil, gas or casinghead gas used for operating, development or production purposes upon said above described lands or unavoidably lost, and no overriding royalty shall be payable upon gas and casinghead gas used for recycling or repressuring operations benefiting said above described lands.
In computing the amounts to be paid Assignor hereunder as above provided, As-signee shall have the right to deduct from the value of the oil, gas, casinghead gas, or the proceeds thereof, upon which said overriding royalty is computed the full amount of any taxes required to be paid on such oil, gas and casinghead gas for or on account of the production or sale thereof, including the so-called gross production or severance taxes.
The express language of the assignment states that the overriding royalty payments shall be based upon the market value of gas produced, saved, and marketed from the leased property. The lease places the obligation on Conoco to market the gas produced on the leased property.
The only deduction from the overriding royalty interest is for taxes on the proceeds of the oil, gas, or casinghead gas that is produced or sold. Under the doctrine of “expressio unius est exclusio alterius,” the listing of particular deductions, without a more general or inclusive term, excludes all deductions except those that are specifically enumerated. See, e.g., Reale v. Board of Real Estate Appraisers 880 P.2d 1205, 1207 (Colo.1994) (discussing doctrine of “expressio unius est exclusio alterius” in the context of constitutional interpretation). When a particular deduction is explicitly set forth in a lease or assignment, the fact that there is silence concerning the deduction of any other *665post-production expenses should be interpreted as a term of the contract, and the deduction of expenses that are not enumerated is prohibited.
There is no specific language in the assignment that post-production costs are to be subtracted from the calculation of the Gar-mans’ overriding royalty interest. In the absence of express language in the assignment, post-production costs to make the gas marketable may not be charged against a holder of an overriding royalty interest without an agreement to share the costs. The assignment does not relieve Conoco of its duty to place the gas into a marketable condition at its own expense.
Accordingly, I concur in the result reached by the majority.
VOLLACK, J., joins in this special concurrence.