CHAPTER 11 RELATIONSHIPS BETWEEN CO-OWNERS IN MARKETING NATURAL GAS
| Jurisdiction | United States |
(May 1987)
RELATIONSHIPS BETWEEN CO-OWNERS IN MARKETING NATURAL GAS
The University of Texas School of Law
Austin, Texas
TABLE OF CONTENTS
Page
I. INTRODUCTION
II. MARKETING BY CO-OWNERS UNDER THE JOINT OPERATING AGREEMENT
A. RIGHTS OF CO-OWNERS IN THE ABSENCE OF A GAS BALANCING AGREEMENT
1. The Owner Who Fails to Market: The Effect of the Operator's Disposition of Gas from the Contract Area
a. The Operator's Options Under the Model Form Operating Agreements -- In General
b. The Operator's Purchase of the Nonoperator's Gas
(1) The Pricing Provisions
(2) The Advantages of Purchasing Rather Than Acting as Agent
(3) The Separate Sales Contract
c. Operator Acting As Agent for the Nonoperator
(1) Problems Involving Prices Under Long-Term Contracts
(2) The Nonoperator's Claims to Take-or-Pay Settlements
(3) The Operator's Obligations in Structuring Take-or-Pay Settlements
(4) The Revised Contract to Purchase Future Gas
d. The Operator's Duty to Obtain the Best Price: The Effect of FERC Order 451
e. The Operator Who Markets All Current Gas Production for Himself
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2. Rights of Marketing Co-owners in the Absence of a Gas Balancing Agreement
a. Rights of a Nonmarketing Owner Who Enters into a Gas Sales Contract: Gas Balancing Problems
b. The Split-Stream Sale
(1) The Operator's Duty To Maintain Balance
(2) Rights of the Underproduced Parties
B. RIGHTS OF CO-OWNERS UNDER A GAS BALANCING AGREEMENT
1. Latent Drafting Problems
a. Unanticipated Consequences of Giving a Balancing Agreement Priority Over the Operating Agreement
b. The Gas Balancing Agreement as the Exclusive Method for Balancing
c. Co-Ordination of Gas Balancing with Take-or-Pay Make-up Clauses
d. MMBtu Pricing and Volumetric Balancing
2. Advantages of the Express Balancing Agreement
C. STATUTORY MODIFICATIONS OF THE RIGHTS AND OBLIGATIONS OF THE OPERATOR AND NONOPERATORS: Oklahoma
III. THE RIGHTS OF ROYALTY OWNERS
A. THE IMPLIED COVENANT TO MARKET
1. The Standard for Breach
2. The Effect of Self Dealing: Sales to a Wholly Owned Subsidiary
B. THE EFFECT OF A SPLIT STREAM CONNECTION ON THE RIGHTS OF ROYALTY OWNERS
1. The "Weighted Average" and "Tract Allocation" Methods of Adjusting the Rights of Royalty Owners
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2. The Texas Problem
C. THE MARKET VALUE ROYALTY PROBLEM: THE EFFECT OF N.G.P.A. PRICE CATEGORIES
1. The Market Value of Price-Regulated Gas
2. The Market Value of Gas Sold Under a "Warranty" Gas Sales Contract
IV. CONCLUSION
FOOTNOTES 33
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RELATIONSHIPS BETWEEN CO-OWNERS IN MARKETING NATURAL GAS
I. INTRODUCTION
Gas marketing decisions rarely involve only the two parties who are involved in negotiating the terms of the gas sales contract. Even if the seller is the sole owner of the lease covered by the gas well unit, he must still consider the potential impact of his marketing decision upon his royalty obligations to his lessor. The royalty clause may require a market value calculation of royalty. Even if it is clearly based on the sale price, there has been an increasing number of cases in which the lessors have successfully argued that the lessee's conduct in entering into a gas sales agreement constitutes a breach of the lessee's implied covenant to market gas "prudently" or "in good faith." In all likelihood, of course, the seller is not the sole owner of the properties in the gas well unit. The seller and a number of other companies or individuals have contributed working interests to the unit and have entered into an operating agreement which governs their rights and duties with respect to the gas production. The operating agreement may, or may not, contain a gas balancing agreement as an attachment, and either its presence or its absence may create problems of interpretation relative to the producer's right to sell the gas.
A paper such as this cannot hope to cover the full variety of issues which may arise among co-owners as the result of gas sales contracts. Many of them have, in fact, been covered by excellent papers at the 1983 Rocky Mountain Mineral Law Foundation Special Institute which dealt with Oil and Gas Agreements.1 I will not attempt to go over that earlier ground in detail. This paper will deal with two separate sets of issues. First, the problems resulting from delayed marketing and split stream sales, especially when there is no gas balancing agreement. Second, claims by a lessor to royalties based on an amount other than received by the lessee.
II. MARKETING BY CO-OWNERS UNDER THE JOINT OPERATING AGREEMENT
In the vast majority of cases the co-owners of working interests in gas producing property have entered into an operating agreement. Although the relationship created by such an agreement is not free from dispute, most courts2 and commentators3 have concluded that the typical joint operation is a joint venture. Each participant stands in a fiduciary relationship with every other participant insofar as the specific enterprise which gave rise to the venture is concerned.4 As a practical matter, of course, the burden of the fiduciary obligation is likely to fall most heavily upon the operator, since he is the most active participant and his
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actions are most likely to effect the other participants.5 This obligation may, however, be modified by a variety of factors, such as the location and type of activity engaged in by the operator.6 In the case of disputes over gas marketing, it is most likely to be affected by the language of the agreement itself, for specific provisions in the operating agreement which set out the rights and duties of the operator and nonoperators will normally prevail over the duty which would otherwise be imposed by the general law of fiduciaries.7
A. RIGHTS OF CO-OWNERS IN THE ABSENCE OF A GAS BALANCING AGREEMENT
All versions of the model form operating agreement8 provide that each party has the right to "take in kind or separately dispose of its proportionate share" of the gas produced from the Contract Area.9 This contractual or property right is commonly exercised, and in many instances the parties to the agreement either all join in a single gas sales contract or each disposes of his proportionate share under a separate contract. In some instances a party either through choice or through inability to obtain a contract delays marketing his share of the gas, even though other parties with interests in the producing well are selling their shares of gas. In all of these situations the rights of the operator, the non-contracting nonoperators, and the gas purchasers may ultimately come into question. If the parties have not entered into a separate gas balancing agreement, their rights depend, at least initially, upon the terms of the Operating agreement.
1. The Owner Who Fails to Market: The Effect of the Operator's Disposition of Gas from the Contract Area
In some instances the operator enters into an agreement disposing of the entire production from the Contract Area without the joinder of the nonoperators. How should this disposition of the entire production be viewed? Is the operator selling only his own gas and thus creating a right in the nonoperators to insist upon some form of make-up or balancing later? Or is he acting as the nonoperator's agent and marketing their shares of gas? Is the operator buying the nonoperator's gas and re-selling it under a separate contract to the pipeline purchaser? The terms of the Operating Agreement establish the acceptable alternative ways of treating the transaction.
a. The Operator's Options Under the Model Form Operating Agreements — In General 10
Under the 1977 model form operating agreement the operator may take the gas attributable to the interest of any nonoperator who does not make arrangements for its separate disposition and deliver
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it for sale to a purchaser. There are three ways in which to characterize this transaction. The authorization to sell or market on behalf of a nonoperator is clearly permissive. The operator is not required to make arrangements on behalf of a noncontracting nonoperator,11 and he has violated no fiduciary duty if he refuses to do so.12 Thus the operator may take all of the current gas production for himself. If he does so, he will be obligated to balance the remainder of production at a later time. Alternatively, the operator may either purchase the gas from the nonoperator and resell it; or he may act as agent and sold the gas on behalf of the nonoperators. The proper characterization of the operator's conduct depends upon the operator himself. Before either purchasing a nonoperator's share of gas or selling gas on behalf of a nonoperator, the operator must advise the nonoperator by giving him 30 days advance notice. If the operator fails to give such notice, he should be viewed as selling only his own gas and having thus undertaken an obligation to balance out his overproduction at some later time.
Under the 1982 model form operating agreement the operator's options depend upon which of the two versions of Art. VI.C. is used. The "basic" version13 presupposes that a gas balancing agreement will be attached to the agreement and stipulates that disproportionate takings of gas must be balanced in accordance with the agreement. Since there is no express provision for the operator to act as agent for the nonoperators or to purchase their shares of gas, any nonoperator who prefers one of these methods of marketing must use a separate agreement to designate the operator as agent or purchaser. The "alternate" version14 is used when there is no separate gas balancing agreement. It gives the operator the same options that are available under the 1977 operating agreement. Thus under both the 1977 and the 1982 model forms, parties who have not...
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