PUMMILL v. HANCOCK EXPLORATION LLC
419 P.3d 1268
Okla. Civ. App.2018Background
- Plaintiffs (Pummill and Parrish heirs) own royalty interests under 1966 leases covering production from the Parrish-Novotny No. 1-32 gas well; the leases contain "gross proceeds" and "market price at the well" royalty clauses.
- Cimarex (operator since 1999) markets gas from the 1-32, sells processed/residue gas downstream, and has varied its royalty calculations and deductions over time; Enogex/Enable is the midstream gatherer/processor handling off-lease field services and plant processing.
- Plaintiffs sued (2011) alleging defendants improperly charged certain gathering, compression, dehydration, processing and other post-production costs against their royalties and breached the implied covenant to market.
- After summary judgment proceedings and a Supreme Court remand for unresolved factual issues (Pummill I), a bench trial was held; the trial court ruled for Plaintiffs, finding the gas was not marketable at the wellhead/custody meter and that defendants failed to meet Mittelstaedt elements to deduct post-production costs.
- On appeal the Court of Civil Appeals affirmed: factual finding that gas was not marketable until after Enogex/Enable processing (tailgate) was supported by competent evidence, and defendants did not prove post-production cost deductions were permissible.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| When is the gas a "marketable product" for royalty purposes? | Marketable only after field gathering/compression/dehydration/processing — at or after gas-plant tailgate. | Marketable at custody transfer meter or wellhead once acceptable to a purchaser; hypothetical wellhead sales sufficient. | Gas was not marketable at or near the wellhead/custody meter; competent evidence supports marketability at/after plant tailgate. |
| May lessee deduct post-production costs (gathering/compression/dehydration/processing) from royalties? | Lessee must bear costs to create marketable product; deductions not allowed unless lease says so or Mittelstaedt elements proven. | Deductions allowed if costs are reasonable and proportionately increase royalty value. | Defendants failed to show Mittelstaedt elements (enhancement, reasonableness, proportional royalty increase); deductions disallowed. |
| Do POP/POI (percent-of-proceeds/index) contracts change royalty entitlement? | Contract form does not alter royalty obligations; services performed govern outcome. | Use of POP/POI with midstream purchasers produces acceptable wellhead sales and can determine royalty base. | Use of POP/POI does not change royalty due under these leases given facts; cannot be used to avoid royalty obligations here. |
| Are royalties owed on gas consumed/used off-lease (fuel, gathering compressors, plant operations)? | Royalty owners entitled to royalty on gas used off-lease per lease terms; operator must pay. | Off-lease consumption is a post-production use or fuel and may be deductible. | Trial court correctly required royalty on off-lease use under the leases; defendants may not deduct such off-lease costs here. |
Key Cases Cited
- Mittelstaedt v. Santa Fe Minerals, Inc., 954 P.2d 1203 (1998 OK 7) (lessee may only burden royalty with post-production costs if it proves enhancement of an already marketable product, costs are reasonable, and royalties increase proportionally)
- Wood v. TXO Production Corp., 854 P.2d 880 (1992 OK 100) (lessee has implied duty to market and prepare product for sale; costs to create marketable product generally borne by lessee)
- Howell v. Texaco, Inc., 112 P.3d 1154 (2004 OK 92) (market value defined as price in a free and open market; lessee must obtain best price reasonably possible)
- TXO Prod. Corp. v. State ex rel. Comm'rs of the Land Office, 903 P.2d 259 (1994 OK 131) (discusses limits on deductions for post-production costs and lessee duties)
- K & H Well Service, Inc. v. Tcina, Inc., 51 P.3d 1219 (2002 OK 62) (bench-trial factual findings are reviewed for competent evidence; legal issues reviewed de novo)
- Fawcett v. Oil Producers, Inc. of Kansas, 352 P.3d 1032 (Kan. 2015) (adopted alternative definition: product is merchantable when delivered in condition acceptable to a purchaser in a good-faith transaction; distinguishable on facts and jurisdiction)