Bice v. Petro-Hunt, L.L.C.

Rule of Law:

In North Dakota, when an oil and gas lease requires royalty based on the 'market value at the well' for sour gas unmarketable at the wellhead, the 'at the well' rule applies, allowing lessees to deduct reasonable post-production processing costs using the work-back method; additionally, a 'free use' clause permits off-lease use of processed gas for essential operations benefiting all lessors; and specific contractual terms govern the reasonableness of risk-capital and depreciation deductions.

Facts:

• Gulf Oil Corporation discovered the Little Knife Field in 1976 and built the Little Knife Gas Plant in the late 1970s to process sour casinghead gas.
• The Little Knife Gas Plant removes hydrogen sulfide and liquid hydrocarbons, with residue gas and other products sold at or downstream of the plant tailgate.
• A dispute between Gulf and royalty owners over gas valuation in the early 1980s led to a 1983 settlement agreement, which stated royalty would be determined by adding revenue from gas/products and subtracting processing costs.
• Petro-Hunt, L.L.C., acquired the Little Knife Gas Plant and interests in the Little Knife Field in 1997, as successor to Chevron and the William Herbert Hunt Trust Estate.
• Petro-Hunt paid royalty on casinghead gas on the same basis to all royalty owners, despite lease clauses calling for payments based on "market value of the gas at the well."
• The gas from the Little Knife Field is sour and has no discernible market value at the well before it is processed to remove hydrogen sulfide and liquid hydrocarbons.
• Petro-Hunt uses residue gas, after processing at the Little Knife Gas Plant, as fuel at three central tank batteries to heat, treat, and separate oil, gas, and water, which are essential functions typically performed at individual well sites.
• The 1983 settlement agreement explicitly allowed a six percent risk-capital charge on undepreciated investment and specified a 13-year straight-line depreciation method, subject to annual review and adjustment for extended economic life.
• Since acquiring the plant, Petro-Hunt made new capital investments totaling over $2 million and adjusted depreciation based on the extended economic life of the plant.
• Petro-Hunt purchased the plant for $6,213,452 (net of salvage value) and has depreciated a total of $7,684,986 out of an $8,341,804 depreciable base (purchase price plus new capital additions).

Procedural Posture:

• In 2001, royalty owners (Plaintiffs) brought suit against Petro-Hunt, L.L.C., in district court, asserting underpaid royalties due to post-wellhead cost deductions.
• The royalty owners were certified as a Class in 2004.
• In February 2007, Petro-Hunt moved for summary judgment, and the Class also requested partial summary judgment.
• On April 30, 2007, the district court granted Petro-Hunt partial summary judgment, determining royalties should be calculated based on the work-back method, allowing deduction of commercially reasonable processing costs.
• The district court refused to rule on the remaining issues at that time because discovery was not complete.
• After discovery was completed, Petro-Hunt again moved for summary judgment.
• In July 2008, the district court granted Petro-Hunt summary judgment on the remaining issues.
• The Plaintiffs, proceeding as a class, appealed from the district court’s order granting Petro-Hunt summary judgment to the Supreme Court of North Dakota.