CHAPTER 11 GETTING PAID FOR OIL AND GAS PRODUCTION
| Jurisdiction | United States |
(May 1986)
GETTING PAID FOR OIL AND GAS PRODUCTION
Assistant General Attorney Texaco Inc.
Denver, Colorado
I. OVERVIEW
In reviewing the treaties, writings, cases and statutes on the subject of sales of and payment for production, no generalized guidelines, rules or directions emerged to illuminate the subject. Only the time-honored division order seems to be recognized as the instrumentality of sale for the collection of proceeds from production. Even though gas sales agreements are more frequently negotiated and are more comprehensive, they are generally considered more as instruments of regulatory compliance rather than of sales contracts. Most articles on collection of proceeds from production attribute the transformation of oil into currency solely to division orders even though no one knows their origin. One writer suggested that the division orders may have appeared on the scene "full grown like Athena from the head of Zeus".1
Not only are division orders of ancient origin, but so are their companions, posted prices and run tickets. There is a disquieting similarity between the practice of using posted crude oil prices for the price to be paid for production under division orders and the archaic practice of striking off a foreclosure sale on the steps of a county courthouse after the Notice of Sale had been nailed to, or posted on, the courthouse door. The posting of prices literally refers to the ancient practice of nailing price quotations to a post in an oil field. The other relic of the times is the "run ticket".
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These tickets are still used for the consummation of sales of oil. These practices of the past still influence and indeed shape the accounting procedures which ultimately determine payments for production.
Even though the law of sales is at the heart of payment for production, the real issue centers on the legally protected rights of the parties and the relationship between leasehold owners and purchasers of production. Any discussion of the rights of parties to get paid for production requires an analysis of title to production and the transfer of such title by sales contracts or otherwise. The transfer of title of personal property (produced oil or gas) suggests a review of the concepts of ownership, particularly as to the land and the legal nature of the oil and gas lease from which the production was obtained. Lastly, the transposition or transition from real property to personal property must be considered.
The transition of title to oil and gas from "real" to "personal" property and from land to barrels, is most clearly enunciated in a 1942 opinion of the Wyoming Supreme Court.2 The issue before the court in a mortgage case was one of construing a party's royalty rights in oil produced from lands when that party disclaimed any interest, ownership or property right in that land. Speaking for the court, Justice Blume concluded:
It is true, of course, that when oil and gas have been brought to the surface, they become personal property. State v. Snyder, 29 Wyo. 163, 196, 212 P. 758. And if the right under the deed to Eades consisted only of the right to receive a certain amount of oil, without reference to its source, then it might well be said that the right is one merely to personal property. But it consists of a right to receive the oil and gas from particular pieces of
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land. That is a factor which cannot be ignored. We accordingly held in State v. Snyder, supra, that when oil is taken from the ground, part of the corpus thereof is taken. So that it can scarcely be doubted that the right is at least partially connected with the land, and cannot be said to be wholly unmixed with one in real property. It may be said, under our terminology dividing property into real and personal, to be one of a dual nature....
The right to a royalty interest in oil does not merely attach after the oil has been personal property.... The right, extending as it does to oil which is to come from particular land, extends to and is necessarily connected with the corpus of the land, and is, accordingly, a right which exists in the oil which still is in place, inchoate though it may be, follows it as it comes from the ground and still is attached after it has become personal property. To call it personal property is but emphasizing a particular stage of the right on its way to fulfillment. The fact that real property, when severed, becomes under our terminology and classification, personal property, should not obscure the real nature of the right. Terminology is convenient, and in fact necessary, but it should not be abused.
Terminology such as "property", "ownership" and "interest" is not only convenient, but necessary; yet, the usage of such descriptive words does not shed much light on the question of "title" which is yet another frequently used term. In his splendid article on surface damages3 , William P. Pearce III looked behind terminology of the words "property" and "ownership" to illustrate the concepts of legally protected rights implicit in this terminology. Although Pearce dealt with the rights between surface owner and mineral owner, his analysis and cited authorities are equally applicable to oil and gas and are reproduced herein.
Simply to state that one has a property right in or owns the surface and another the minerals, however, does not shed any light on their mutual rights and duties. That question can be clarified only by looking behind the descriptive words "property" and "ownership".
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In the first place, it is necessary to distinguish between the right of ownership itself and the subject matter of that right.... It is necessary to realize, however, that although "property" is often used in this loose way to refer either to the thing itself or to the rights in that thing, the concept of ownership itself is quite distinct from any tangible things to which it may relate for it is no more than the expression of a legal relationship resulting from a set of legal norms....
For this purpose, it may be said that ownership is not a single category of legal "right" but is a complex bundle of rights whose precise character will vary from legal system to legal system. D. Lloyd, THE IDEA OF LAW 319, 323 (1964).
Thus, "property", as a legal concept, connotes not a thing in itself but rather certain rights. These rights are not between the owner and some thing or object, but are rights between the owner and other persons with respect to that thing or object. As a general principle, the nature of private property is the right to exclude others from exercising power or control over, or enjoying the fruits of, some object or thing. M. Cohen, LAW AND THE SOCIAL ORDER 45, 46 (1933).
All civil societies must, if perpetual conflict is to be avoided, regulate the control which diverse persons may exercise over the same object. M. Cohen, REASON AND LAW 109 (1950).
This concept of the enjoyment by one person of a certain bundle of rights in a thing, such as land, enforceable by the sanctions of law against other persons, is at the heart of the common law theory of private property.
A legal right is nothing but a permission to exercise certain natural powers, and upon certain conditions to obtain protection, restitution, or compensation by the aid of the public force. Just so far as the aid of the public force is given to a man, he has a legal right....
...
But what are the rights of ownership? ... Within the limits prescribed by policy, the owner is allowed to exercise his natural powers
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over the subject matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one. O. Holmes, THE COMMON LAW 214, 246 (1881).
After oil or gas have been brought to the surface and contained, they become personal property and the legal concepts of enjoyment of the bundle of rights in the oil produced inure to and are vested in the lessee/producer. The producer is regarded as having "title" or the legal right to exercise control over the production by the aid of public force.
The dispositive issue centers on who as between owners and operators have exclusive or correlative "title" to the production and how such title is transferred to a purchaser in exchange for money or "proceeds". This paper will focus on the legal "protection, restitution or compensation" afforded the producer for the transfer of title to the products of the earth which were first sold as medicine or illuminating petroleum products or flared as a useless by-product.
II. INTRODUCTION TO SALES CONTRACTS
Division orders are accorded the distinction of being the original contracts designed for the purchase of crude oil. However, even before division orders appeared on the scene4 , sales of crude oil occurred. In fact, the first recorded oil case resulted from the sale of and payment for petroleum. In 1858, one Samuel Kier claimed to have sold nearly 240,000 half-pint bottles of Rock Oil at a price of $1.00 per bottle.5 The owner of lands who had leased the land to Kier for boring salt wells and manufacturing
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salt sued Kier in trover for the conversion of 50,000 gallons of carbon oil.6 It is interesting that the law of oil and gas had its origin in case in which landowner/Lessor's primary action was to recover the proceeds collected by his Lessee from the sale of oil. In order to succeed, he had to prove that his title, right or ownership was superior to that of his Lessee. This he was unable to do. Kier's possession was held to be rightful, so he was accountable to no one, not even the landowner/Lessor.
The law of oil and gas has been enlarged and refined but the practices of selling and collecting for crude oil have changed little from the last century...
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