Lease Language Clearly Means That Royalty To Be Computed At the Well.

This case involved construction of a clause contained in oil and gas leases that computed the royalty owed to lessors in a class action suit.  The producer, Oil Producers, Inc. of Kansas (OPIK) is a small producer that produces gas in areas served by midstream companies (third-party purchasers).  OPIK owns the well and the midstream companies own the gas gathering and processing facilities.  Thus, OPIK sells the gas at the wellhead to the midstream companies who process the natural gas for eventual delivery into the interstate pipeline system.  The price that OPIK receives for the raw gas it sells to the midstream companies is based on a formula that allows OPIK (and royalty owners) to jointly share in "downstream" market values as the gas gets closer to the consumer after deduction for expenses to account for services provided by the midstream companies to process the gas and transport it from the wellhead to the downstream resale location.  OPIK pays the royalty owners a percentage of what OPIK receives, thus the royalty owners share in the expenses incurred to get the gas to consumers.  Many of the leases contained a provision stating that, "The lessee shall pay lessor as royalty 1/8 of the proceeds from the sale of gas at the mouth of the well where gas only is found."  Another lease document provided for "one-eighth (1/8) of the proceeds if sold at the well...".  The royalty owners claimed that they should not have to share in the production expenses because the duty to market the minerals produced was on OPIK and that duty meant that OPIK solely bore the burden of the expenses necessary to make the gas marketable.  The trial court and court of appeals agreed with the royalty owners, effectively negating the "at the well" language of the oil and gas leases.   The lower courts held that OPIK had to take the proceeds it received from the midstream companies and add to it the amounts that the midstream companies spent to make the gas marketable so as to obtain higher prices downstream.  This had the effect of making OPIK pay a royalty on selling prices of gas that it did not receive.  On further review, the Kansas Supreme Court reversed.  The Court noted that prior Kansas caselaw held that the term "proceeds" in a royalty clause similar to the clause involved in this case referred to gross sale price in the contract between the first purchaser and the operator (except for the statutorily withheld conservation fee which is borne by the operator as a mill levy on gas the operator sells).  The Court held that OPIK satisfied its duty to market minerals by entering into the purchase agreements with the midstream companies for sale of gas at the wellhead.  That is when gas has been "marketed."  Thus, where, as in this case, the lease provides for royalties based on a share of proceeds from the sale of gas at the well, the post-production, post-sale processing expenses deducted by the third-party are taken into account when computing the "proceeds" paid to OPIK and impact the amount of the royalty paid to the lessors.  Fawcett v. Oil Producers of Kansas, No. 108,666, 2015 Kan. LEXIS 376 (Kan. Sup. Ct. Jul. 2, 2015).