Case Summary: Newfield Exploration Company et al.
v. State of North Dakota et al., No. 2019 ND 193
Written by Chloe Marie – Research Specialist
On July 11, 2019, the Supreme Court of North Dakota
concluded that post-production costs relating to the processing of gas into a
marketable form could not be subtracted from royalties paid to the State of
North Dakota. This article provides a comprehensive summary of this case.
Background
Newfield, an oil and gas company, entered into several
natural gas leases with the State of North Dakota containing provisions that
required royalties to be calculated based on gross proceeds from the sale of
the gas. Newfield agreed to sell the gas produced at the wells to Oneok Rockies
Midstream, LLC; however, royalty payments were to be made only after Oneok put
the gas into marketable form and sold it. The manner in which Newfield actually
paid royalties to the state was described by the Supreme Court in the opinion
as follows: “[t]he price Oneok pays to Newfield for the gas is calculated
based on 70-80% of the amount received by Oneok when Oneok sells the marketable
gas. The 20-30% reduction of the price for which the marketable gas is sold
account for Oneok’s cost to process the gas into a marketable form and profit.”
In June 2016, the State of North Dakota initiated an audit of Newfield and
later argued that the audit revealed that Newfield did not pay enough royalties
on the gas sold under the leases. More particularly, the State of North Dakota
claimed that “Newfield is paying royalties based on gross proceeds reduced to
account for deductions necessary to make the gas marketable and that reducing
the gross payments by those deductions is contrary to the express terms of the
lease.”
Subsequently,
Newfield brought legal actions against the State of North Dakota seeking a
Court Order declaring that the royalty payments were calculated correctly based
upon the gross amount Newfield received from Oneok. After both parties moved
for summary judgment, the District Court of McKenzie County, Northwest Judicial
District, ruled in favor of Newfield’s motion for summary judgment agreeing
that the lease “allows the reduction of the royalty payments to account for
expenses incurred to make the natural gas marketable.”
The State of North
Dakota appealed the District Court’s decision to the Supreme Court of North
Dakota alleging that the District Court erred in its interpretation and that such
method of calculation was the wrong way forward. The State argued that sharing in
the post-production costs was contrary to the leases while Newfield countered
that “it can pay a royalty based on a payment that has been reduced to account
for the expense of making the gas marketable, as long as the expense is
incurred by a third party.”
The North Dakota
Supreme Court’s ruling
The State Supreme
Court opined that, as a general rule, the lessor and lessee should apportion
the costs of making the product marketable between them, unless otherwise
specified in a contract.
Subpart (f) of the
leases contained royalty provisions stating that “[a]ll royalties … shall be payable on an amount
equal to the full value of all consideration for such products in whatever form
or forms, which directly or indirectly compensates, credits, or benefits
lessee.” The Supreme Court interpreted the language in Subpart (f) as clearly
meaning that “the State’s royalty must include the value of any consideration,
in whatever form, that directly or indirectly compensates, credits or benefits
Newfield.”
Here, the Supreme Court observed that it was apparent
that the “full value of the consideration paid to Newfield is not determined
until Oneok has incurred the cost of making the gas marketable and subsequently
sold the gas.” In other words, Newfield based its royalty calculation on the
amount Oneok received for the marketable gas. This amount was later reduced to
reflect the post-production costs incurred by Oneok. The Supreme Court found it
to be unequivocal that Newfield benefitted from the post-production costs incurred
by Oneok to make the gas marketable and consequently paid less in royalties to
the State. As such, the court held that such method of calculation was contrary
to the language of the leases.
Based upon this reasoning, the Supreme Court reversed
the District Court’s judgment on July 11, 2019, ruling that “[g]ross proceeds from
which the royalty payments under the leases are calculated may not be reduced
by an amount that either directly or indirectly accounts for post-production
costs incurred to make the gas marketable.”
References:
This
material is based upon work supported by the National Agricultural
Library, Agricultural Research Service, U.S. Department of Agriculture.
