BEFORE THE OIL AND GAS CONSERVATION COMMISSION
OF THE STATE OF COLORADO
IN THE MATTER OF THE PAYMENT OF PROCEEDS TO PATRICK L. SHUSTER AND TONI M. SHUSTER FROM PRODUCTION OF OIL AND GAS AS ESTABLISHED BY SECTION 34-60-118.5, C.R.S., MAMM CREEK FIELD, WILLIAMS FORK FORMATION, GARFIELD COUNTY, COLORADO
CAUSE NO. 1
DOCKET NO. 171200792
ORDER NO. 1-209
report of the Commission
The Commission heard this matter on July 30, 2018, at the Colorado Oil and Gas Conservation Commission (“Commission” or “COGCC”), 1120 Lincoln Street, Suite 801, Denver, Colorado, upon application for a hearing on the Commission’s jurisdiction over a payment of proceeds dispute between Patrick L. Shuster and Toni M. Shuster, as Applicants, and Antero Resources Corporation and Ursa Operating Company LLC, as Protestants.
The Commission finds as follows:
1. Patrick L. Shuster and Toni M. Shuster (collectively “Applicants”), as the applicants herein, are interested parties in the subject matter of the above-referenced hearing.
2. Antero Resources Corporation (“Antero”) and Ursa Operating Company LLC (Operator No. 10447) (“Ursa”) (collectively “Protestants”), as the protestants herein, are interested parties in the subject matter of the above-referenced hearing.
3. Due notice of time, place, and purpose of the hearing has been given in all respects as required by law.
4. As a threshold issue, the Commission is required by § 34-60-118.5(5.5), C.R.S. to first determine if it has jurisdiction over this matter. The Commission has authority to promulgate the hereinafter prescribed order pursuant to the Oil and Gas Conservation Act (“Act”), §34-60-101, et seq.
PROCEDURAL AND FACTUAL HISTORY
5. This matter presents a payment of proceeds dispute. Applicants claim that Antero and Ursa have not properly paid royalties due to Applicants.
6. This matter did not begin in front of the Commission. Applicants first filed a complaint alleging royalty underpayments in Garfield County District Court (16CV30049). Protestants filed a motion to dismiss for failure to exhaust administrative remedies, which the District Court granted without prejudice on August 16, 2017.
7. Applicants’ Amended Application, filed in April 2018, requests that the Commission enter an order finding that the Commission does not have jurisdiction over the instant dispute. Protestants request that the Commission deny Applicants’ request and decide this matter on the merits.
8. On June 18, 2018, the Hearing Officer required the submission of Expanded Prehearing Statements (“EPS”) from each party, in order to clarify the specific arguments, and the legal basis relied upon for same. Applicants submitted their EPS on June 25, 2018, and the Protestants’ Response was filed on July 2, 2018. No reply was authorized.
9. A Final Prehearing Conference (“Final PHC”) was held at the Commission on July 16, 2018. All parties were present and represented by legal counsel.
10. Following the Final PHC, the Hearing Officer issued a Final Prehearing Order which, among other things, set forth stipulated facts, identified the disputed issue, consolidated this matter with Docket Nos. 171200790 and 171200791 for purposes of hearing, and provided each side with 15 minutes to argue the disputed issue.
11. The Stipulated Facts in the Final Prehearing Order identified a September 24, 2005 Lease (“Lease”). See Stipulated Fact No. 16, Final Prehearing Order.
12. The parties also stipulated that Ursa is successor-in-interest to the Lease. Id.
13. The parties stipulated that the applicable royalty provisions in the Lease are as follows:
4.1.2 Gas. On all hydrocarbon gas, including casinghead gas and all other hydrocarbon gaseous substance, and hydrogen sulphide produced from the Leased Premises, as follows:
[t]he “value” (as determined hereafter) of eighteen and one-half percent (18.5%) of all liquid or gaseous hydrocarbons extracted or obtained from such gas by any method, on or off the Leased Premises;
As set forth at Paragraph 4.2 of the Lease Agreements, relating to the determination of “Value” of the Royalty under Paragraph 4.1.2 on gas and gaseous substance and products therefrom produced from the Leased Premises, “Value” shall be determined as follows:
4.2.1 “Value” for purposes of 4.1.2 (i) and (ii). The “value” of all liquid and gaseous hydrocarbons and other Minerals under which the Royalty is determined under Paragraph 4.1.2(i) and (ii) shall be:
(a) Their selling price, if sold under bona fide contracts of sale with Third Persons, or
(b) If they are not so sold to Third Persons, the fair and reasonable value thereof at the place where sold or used.
The term “Third Person,” as used in Paragraph 4.2.1(a), is defined, at Paragraph 1.1.9 of the Lease Agreements, to mean:
any person, firm or corporation not a subsidiary or affiliate of Lessee, with whom Lessee deals in arms-length and with whom Lessee has no processing contract involving production from the leased premises or other arrangement involving an exchange of production from the Leased Premises for other production, or a reciprocal allowance or discount on such production, or any reciprocal advantage, direct or indirect, resulting from any contract or arrangement. Any sale of production pursuant to any contract, or arrangement, or other commitment existing as of the date of this Lease shall not be deemed a sale to a Third Person. An ‘affiliate’ includes any individual, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture, firm or other entity or person directly controlling, controlled by or under common contract with Lessee. For purposes of this paragraph “control” means ownership of fifty percent (50%) or more of the voting securities or equivalent voting rights.
An additional royalty provision is set forth in Paragraph 4.5 of the Lease Agreements, states:
No Reduction for Costs. Lessee shall pay to Lessor the royalties free of all costs of any kind, including, but no limited to, costs of gathering, production, transportation, treating, compression, dehydration, processing, marketing, truck or other expense, directly incurred by Lessee, whether as direct charge or a reduced price or otherwise. In this regard, Lessee agrees to bear one hundred percent (100%) of all costs and expenses incurred in rendering hydrocarbons produced on or from the leased premises marketable and delivering the same into the first interstate pipeline. Additionally, said royalties shall never bear, either directly or indirectly, under any circumstances, the costs or expenses (including depreciation) to construct, repair, renovate or operate any pipeline, plant or other facilities or equipment used in connection with the treating, separation, extraction, gathering, processing, refining, compression, manufacturing or marketing of hydrocarbons produced from the leased premises or land pooled therewith.
See Stipulated Fact Nos. 17-18, Final Prehearing Order.
14. None of the parties dispute the existence or applicability of the Lease. At the Final Prehearing Conference on July 16, 2018, all parties confirmed on the record that the Lease is not silent regarding the allocation of post-production costs.
15. On July 18, 2018, the Hearing Officer issued a Recommendation recommending that the Commission dismiss Applicants’ Amended Application without prejudice, for lack of jurisdiction.
16. Generally, the Commission does not have the jurisdiction to interpret contracts. Chase v. Colorado Oil and Gas Conservation Comm’n., 284 P.3d 161, 168 (Colo. App. 2012) (holding that the Act does not specifically provide the Commission has an express or implied power to interpret a lease, and that the Commission’s determination that it lacked jurisdiction to interpret a lease was reasonable).
17. Section 34-60-118.5 of the Act defines the Commission’s jurisdiction over disputes regarding the payment of royalties. The Commission has jurisdiction to decide: 1) the date upon which payment is due to a payee; 2) whether there is a justifiable delay in payment; and 3) the amount of proceeds due to a payee from a payor. §34-60-118.5(5)(a) – (c), C.R.S. However, before the Commission may decide any of the above three issues, it must “determine whether a bona fide dispute exists regarding the interpretation of a contract defining the rights and obligations of the payer and payee.” §34-60-118.5(5.5), C.R.S. “If the commission finds that such a dispute exists, the commission shall decline jurisdiction over the dispute and the parties may seek resolution of the matter in district court.” Id.
18. The Commission has discretion to interpret the Act. See Colorado State Personnel Bd. v. Department of Corr., 988 P.2d 1147, 1151 (Colo.1999) (deference is given to an agency's reasonable interpretation of its statute when it “lighten[s] the agency's workload and mak[es] its decision-making process more efficient” as long as it is consistent with the intent and purpose of the statute).
19. The interpretation of a contract is a question of law. Fed. Deposit Ins. Corp. v. Fisher, 292 P.3d 934, 937 (Colo. 2013). The primary goal in contract interpretation is to ascertain and implement the intent of the parties. Id. Black’s Law Dictionary defines interpretation as “the ascertainment of a text’s meaning; specif., the determination of how a text most fittingly applies to particular facts.” Black's Law Dictionary (10th ed. 2014).
20. Under Section 118.5(5.5), the Commission must not only determine if a dispute regarding the interpretation of a contract exists, the Commission must also decide if the dispute is “bona fide.” Black's Law Dictionary (10th ed. 2014), defines “bona fide” as follows: “In or with good faith; honestly, openly, and sincerely; without deceit or fraud. . . . Real, actual, genuine, and not feigned.”
21. The Commission does not have jurisdiction to decide whether a royalty owner is entitled to payment under a lease or other contract. Grynberg v. Colorado Oil & Gas Conservation Comm’n, 7 P.3d 1060 at 1063 (Colo. App. 1999) held:
Section 34–60–118.5 does not create an entitlement to proceeds; it presumes the existence of such an entitlement and imposes deadlines for the payment to those legally entitled to receive payment. The statute demonstrates the General Assembly's intent to grant to the Commission jurisdiction only over actions for the timely payment of proceeds and not over disputes with respect to the legal entitlement to proceeds under the terms of a specific royalty agreement.
22. The legislature removed disputes that require the interpretation of a contract from the Commission’s jurisdiction in order to preserve the state’s interest in consistent resolution of complex legal questions. In Grynberg, the Court of Appeals discussed purpose of Section 118.5:
Section 34–60–118.5 confers jurisdiction upon the Commission to calculate the amount of proceeds due a payee and to enforce the timely payment of those proceeds, but it leaves to the courts the authority to decide contractual disputes, such as a determination of a potential payee's legal entitlement to proceeds. These types of disputes may involve not only contractual interpretation, but the application of complex legal principles if, for example, a payor is claiming the right to deduct post-production costs. Thus, by reserving the determination of contractual disputes for the courts, § 34–60–118.5 promotes the state's legitimate interest in ensuring the proper and consistent resolution of complex legal questions.
7 P.3d at 1064.
23. The Commission has jurisdiction to decide if and when payment is due where there is no contract between the parties. In Grant Brothers Ranch, LLC v. Antero Resources Piceance Corporation, et al., the Colorado Court of Appeals found that the Commission had jurisdiction over a royalty payment dispute because, as the plaintiff had been statutorily pooled, there was no contract between the parties to interpret. 409 P.3d 637 (Colo. App. 2016). In reaching its conclusion, the Court found that the Commission has “primary jurisdiction over disputes for the payment of proceeds such as the one before us.” Id. at 644.
24. The Colorado Supreme Court has defined “marketability” for purposes of calculating royalties when a lease is silent and held that the determination of whether gas is marketable is a question of fact. In Garman v. Conoco, Inc., the Colorado Supreme Court ruled that the implied covenant of marketability is included in every oil and gas lease. 886 P.2d 652 (Colo. 1994). When a lease is silent as to the deduction of costs from a royalty, the implied covenant of marketability requires “the lessee to incur those post-production costs necessary to place gas in a condition acceptable for market.” Id. at 659.
25. In Rogers v. Westerman Farm Co., the Colorado Supreme Court defined “marketability”:
In sum, in defining marketability under the implied covenant to market, we look to the first-marketable product rule for guidance. Gas is marketable when it is in the physical condition such that it is acceptable to be bought and sold in a commercial marketplace, and in the location of a commercial marketplace, such that it is commercially saleable in the oil and gas marketplace. The determination of whether gas is marketable is a question of fact, to be resolved by a fact finder.
29 P.3d 887, 904 (Colo. 2001)
SUMMARY OF THE PARTIES’ POSITIONS
26. In their EPS, Applicants assert: 1) the Protestants paid royalties based upon sale prices that were lower than those actually realized to third persons for residue gas; 2) the royalty calculations for the five natural gas liquid products were based on artificially low sales prices; 3) as to the condensate, Applicants appear to argue that the Protestants breached the lease by failing to pay royalties on same, and instead have transferred the condensate to outside parties who perform the gathering and processing; and 4) the Protestants improperly made excessive severance and ad valorem tax deductions. See EPS, at 1-3.
27. As support for these assertions, Applicants state that several sections of the Lease control. Id. at 3-5. Applicants also rely on the Protestants’ written responses to the Applicants notices of failure to make timely payments, which response that stated the royalties were calculated on the fair and reasonable value of the hydrocarbons where they were sold or used. Id. at 6-7. Finally, Applicants assert that the excessive taxes withheld were in violation of C.R.S. §§ 39-7-102 and 39-29-111(1)(a). Id.
28. In the Responses, the Protestants state: “without citing to any section of the leases that is in dispute, [the Applicants] make the general assertion that there is a bona fide issue of contract interpretation.” See Response at 1, ¶ 3.
29. The Protestants argue that the factual determinations of whether post-production costs were or were not taken and whether those deductions were taken prior to the point of marketability are factual determinations well within the jurisdiction of the Commission. Id. at 2, ¶ 2. “In summary, Applicants do not point to one word in the…Leases to which they claim a “bona fide dispute exists regarding the interpretation of a contract.”” Id. at 3, ¶ 1.
30. On July 30, 2018, the Commission heard oral argument on the Commission’s jurisdiction over this matter.
31. The parties agreed that, in the interests of time, all arguments made in Docket Nos. 171200788 and 171200789 would be treated as though they were made in full in this matter.
32. Prior to the argument in Docket No. 171200788, Commissioner Jolley disclosed that he had previously been a plaintiff in two royalty payment suits against operators. He stated that that those lawsuits had been resolved and that the Protestants were not parties to the lawsuits. Commissioner Jolley stated that he could be impartial and that he intended to participate in these matters. No Commissioner, party, or member of the public objected to Commissioner Jolley’s participation in Docket No. 171200792.
33. Applicants argued that the Lease specifically prohibits the Protestants from deducting any post-production costs. Applicants argued that, for the residue and natural gas liquid products, the Protestants failed to pay royalties based on the sales price to “Third Persons,” at the delivery points where such products were sold to “Third Persons.” Applicants argued that the Protestants deducted transportation, processing, and treating costs from the selling price, which is prohibited by the Lease.
34. Applicants summarized the Protestants’ position based on statements made in response to Applicants’ notice of failure to make timely payments. Applicants alleged the Protestant’s position is that they have paid on fair and reasonable value of the gas at the place where sold or used, and that the Lease allowed Protestants to charge the reservation fee to guarantee access to interstate pipelines. Applicants cited to Bates Nos. 002634 for its summary of Protestant’s position.
35. Protestants argued that the meaning of language in the Lease is clear and there is no dispute as to the meaning of the language. Therefore, Protestants argued, there is no dispute over the interpretation of a contract and the Commission has jurisdiction. Protestants also argued that Applicants’ arguments only involve applying facts to the clear terms of the Lease. Protestants argued the determination of “market value” is a factual determination.
36. Co-Vice Chair Boigon asked the parties if there was a dispute over the meaning of the term “Third Person” in the Lease. Applicants responded that they disputed that Protestants first sale of gas was a sale to a Third Person as defined by the Lease. Protestants responded that Paragraph 1.1.9 of the Lease clearly defined “Third Person,” and the dispute was a question of fact for the Commission.
37. Chairman Benton asked the parties if the natural gas liquids were actually sold. Protestants responded that the question was not relevant to the issue of jurisdiction because the Lease is clear. Applicants responded that the Protestants claimed they were appropriately paying under a prior sale contract, which was not to a Third Person. Applicants further responded that its position was the Protestants must pay royalties based on the sales price to a Third Person, but that Protestants took the position that they could deduct certain costs under the Lease. Protestants reiterated that Applicants were not challenging the meaning of a single term in the Lease.
38. Chairman Benton asked if reviewing the no-cost provisions of the Lease to determine whether costs may be charged was interpretation of the contract. Protestants responded that it was still simply an issue of applying facts to clear contractual language. Applicants responded that if the Commission cannot decide the rights and obligations of the parties under contract without interpreting the contract.
39. Commissioner Hawkins asked Protestants if there is clear language in the Lease that allows Protestants to charge a reservation fee to Applicants’ royalties. Protestants responded that Commissioner Hawkins’ question was a factual issue that only involved applying facts to the clear terms of the Lease.
40. Commissioner Jolley asked if Applicants were asserting that it was not paid royalties at all for natural gas liquids. Applicants asserted that previously they received no payment for natural gas liquids as Antero transferred those natural gas liquids in exchange for service. Applicants asserted that subsequently, they were paid for the natural gas liquids, but the Protestants deducted transportation and other costs from that royalty amount.
41. Upon inquiries from the Commission in Docket No. 171200788, counsel for Airport stated that, in order prove the point of marketability, royalty owners would need to put on its own witnesses for factual testimony, as well as expert witnesses on the location of the commercial market, the method of marketing natural gas, when NGLs are first marketable, and accounting practices. Protestants stated that the presentation would be less complex, and would only require an expert on marketability, an accountant to explain accounting practices, and lay witness to explain how payments were actually made.
42. Upon inquiries from the Commission in Docket No. 171200788, counsel for Airport asserted that discovery would be necessary, could take up to a year, and would involve thousands of pages of documents. Protestants claimed that discovery would be much less involved.
43. The Commission closed the record and deliberated.
44. The Commissioners stated that their comments from Docket Nos. 171200788 and 171200789 would apply to this matter as well.
45. In Docket No. 171200788, Co-Vice Chair Boigon stated that this matter was a highly contested case that was likely to involve significant discovery and that Commission does not have the expertise, process, or resources to be immersed in these type of royalty disputes.
46. In Docket No. 171200788, Commissioner Hawkins stated that he would be hard-pressed to provide with Commission with any expertise in the midstream issues raised in this case.
47. In Docket No. 171200788, Co-Vice Chair Holton stated that this matter was too complex for the Commission to resolve.
48. Co-Vice Chair Boigon stated that the Commission has never heard these types of contractual disputes.
49. Following deliberations, the Commission voted unanimously to dismiss the Amended Application for lack of jurisdiction.
50. Based on the statements and descriptions of the dispute from the parties at hearing, the Commission finds that the parties have a bona fide dispute regarding the interpretation of a contract. Applicants’ position is that the Lease prohibits the deduction of any costs. Protestants are deducting certain costs and allege that such deductions are allowed under the lease. To resolve this dispute, the Commission would be required to determine how the cost prohibition in Paragraph 4.5 interacts with the provisions of Paragraph 4.2.1, which provide that the value upon which a royalty is to be paid is based on the selling price. In effect, the Commission would be required to determine if Paragraph 4.5’s prohibition on the deduction of costs overcomes Paragraph 4.2.1’s definition of value.
51. Applicants allege that the Protestants at one point transferred gas to a third party in exchange for services, rather than selling the gas. The Commission would be required to interpret the Leases to determine whether a royalty must be paid when gas is not sold.
52. Applicants allege that certain sale of gas are not sales to “Third Persons” under the Lease. To resolve this allegation, the Commission would be required to interpret Paragraph 1.1.9.
53. Finally, Applicants allege that Protestants deducted a reservation fee from their royalty payments. Paragraph 4.5 of the Lease provides that the royalties are to be “free of all costs of any kind.” Paragraph 4.5 lists certain types of costs, but does not mention reservation fees. To resolve this claim, the Commission would be required to interpret Paragraph 4.5, and other provisions, of the Lease to determine if reservation fees are included the categories of costs that may not be deducted from Applicants’ royalty.
54. As a bona fide dispute regarding the interpretation of a contract exists, the Commission must decline jurisdiction under §34-60-118.5(5.5).
55. Further, the Commission concludes that the legislature did not intend for the Commission to have jurisdiction over royalty disputes where the rights and obligations of the parties are determined by a contract, particularly where resolving the dispute would involve the application and interpretation of complex legal principals. “These types of disputes may involve not only contractual interpretation, but the application of complex legal principles if, for example, a payor is claiming the right to deduct post-production costs. Thus, by reserving the determination of contractual disputes for the courts, § 34–60–118.5 promotes the state's legitimate interest in ensuring the proper and consistent resolution of complex legal questions.” Grynberg, 7 P.3d at 1063.
56. The purpose of Section 118.5 was to provide royalty owners with a simple and easy process to obtain payment when an operator delays payment. See Commission Order No. 1-73 (“[Section 118.5] is intended to prevent unscrupulous operators from delaying the payment of proceeds and wrongfully withholding or using funds that are attributable to a Payee’s interest.”) (Citing testimony by Representative Jerkey on House Bill 1113 before the House Agricultural Committee, January 25, 1989).
57. Section 118.5 originally provided that the Commission had “exclusive” jurisdiction over payment of proceeds, but was amended in 1998 to remove the word “exclusive” and clarify the Commission’s jurisdiction. “The amended provisions now provide that the Commission shall have jurisdiction, but not exclusive jurisdiction, only ‘[a]bsent a bona fide dispute over the interpretation of a contract for payment,’” Grynberg, 7 P.3d at 1063. “Indeed, as originally enacted and the amendment both provide evidence of the General Assembly's intent to exclude the resolution of contractual disputes from the jurisdiction of the Commission.” Id. (emphasis supplied). The Commission thus does not have exclusive or primary jurisdiction over this dispute. Grant Bros only holds that the Commission has primary jurisdiction over royalty disputes where there is no contract between the parties.
58. The Commission’s jurisdiction over payment of proceeds disputes is narrow. The Commission only has jurisdiction to make three types of decisions: 1) the date upon which payment is due to a payee; 2) whether there is a justifiable delay in payment; and 3) the amount of proceeds due to a payee from a payor. §34-60-118.5(5)(a) – (c), C.R.S. The Commission interprets these three decisions to be only related to calculation of a royalty amount, and not to include a determination of how the royalty amount is to be calculated.
59. Protestants admitted at hearing that their interpretation of the Commission’s jurisdiction could lead to a situation where a court would submit factual questions on royalty disputes to the Commission, while the court retained decision-making authority over legal issues or issues of contract interpretation. The Commission concludes the legislature did not intend to for Section 118.5 to result in such a complex and lengthy procedure. As stated above, the purpose of Section 118.5 is to provide royalty owners with a simple process to obtain payment. Protestants cite to Lake Durango Water Co. v. Pub. Utilities Comm'n of State of Colorado, 67 P.3d 12, 21 (Colo. 2003), as modified on denial of reh'g (Apr. 28, 2003) for the proposition that courts may decide legal questions while an agency decides factual questions. Lake Durango Water Co. however, did not interpret the Commission’s jurisdiction under Section 118.5 and does not compel a different conclusion.
60. The Commission finds that resolving this matter would require significant discovery and hearing time and concludes that the Commission does not have the process or resources to conduct such complex and involved disputes. The Commission meets approximately eight times a year, and meetings have historically lasted for one or two days. Seven of the nine Commissioners are volunteers and the remaining two Commissioners are the Executive Directors of the Colorado Department of Natural Resources and the Colorado Department of Public Health and Environment. §34-60-104(2)(a)(I), C.R.S.
61. The Commission further finds it does not have the expertise necessary to resolve this dispute. The Act does not require that any of the Commissioners have a legal background, or have a background in midstream operations. The Commission’s expertise is in the technical and scientific aspects of the production of oil and gas. While three members of the Commission are required to have “substantial experience in the oil and gas industry,” two of those Commissioner must have a “college degree in petroleum geology or petroleum engineering.” Id. Further, only one Commissioner is required to be a royalty owner, and that Commissioner must also be involved in agriculture. Id.
IT IS HEREBY ORDERED:
1. Applicants’ Amended Application is DISMISSED WITHOUT PREJUDICE as the Commission lacks jurisdiction to hear the dispute.
2. The Commission also hereby ADOPTS the Hearing Officer’s Recommendation.
IT IS FURTHER ORDERED:
1. The provisions contained in the above order shall become effective immediately.
2. The Commission expressly reserves its right, after notice and hearing, to alter, amend or repeal any and/or all of the above orders.
3. Under the State Administrative Procedure Act the Commission considers this Order to be final agency action for purposes of judicial review within 35 days after the date this Order is mailed by the Commission.
4. An application for reconsideration by the Commission of this Order is not required prior to the filing for judicial review.
ENTERED this 29th day of August, 2018, as of July 30, 2018.
OIL AND GAS CONSERVATION COMMISSION
OF THE STATE OF COLORADO
Julie Spence Prine, Secretary
CERTIFICATE OF SERVICE
On August 29, 2018, a true and correct copy of the foregoing was sent by electronic mail to the following:
Attorneys for Applicants
Attorneys for Antero Resources Corporation and
Ursa Operating Company LLC
Margaret Humecki, Hearings Assistant