Patrick D. Leggett v. EQT Production Co. , 239 W. Va. 264 ( 2017 )

IN THE SUPREME COURT OF APPEALS OF WEST VIRGINIA
January 2017 Term
FILED
No. 16-0136 May 26, 2017
Released at 3:00 p.m.
RORY L. PERRY II, CLERK
SUPREME COURT OF APPEALS
PATRICK D. LEGGETT, et al.,
Plaintiffs Below, Petitioners,
v.
EQT PRODUCTION COMPANY, et al.,
Defendants Below, Respondents.
Certified Questions from the
United States District Court for the Northern District of West Virginia
The Honorable Fredrick P. Stamp, Jr., Judge
Case No. 1:13-cv-00004-FPS
CERTIFIED QUESTIONS ANSWERED
Rehearing Granted: January 25, 2017
Submitted Upon Rehearing: May 2, 2017
Filed: May 26, 2017
Marvin W. Masters, Esq. David K. Hendrickson, Esq.
Richard A. Monahan, Esq. Carl L. Fletcher, Jr., Esq.
April D. Ferrebee, Esq. Hendrickson & Long PLLC
The Masters Law Firm lc Charleston, West Virginia
Charleston, West Virginia Attorneys for Respondents
and
Michael W. Carey, Esq.
Carey, Scott, Douglas & Kessler, PLLC
Charleston, West Virginia
Attorneys for Petitioners
Howard M. Persinger, III, Esq.
Persinger & Persinger, L. C.
Charleston, West Virginia
Attorney for Amici Curiae
West Virginia Land and Mineral Owners’
Association, West Virginia Royalty Owners’
Association, West Virginia Farm Bureau,
National Association of Royalty Owners,
Appalachia, and Lewis Maxwell Oil & Gas LLC
Timothy M. Miller, Esq.
Mychal S. Schulz, Esq.
Katrina N. Bowers, Esq.
Babst, Calland, Clements & Zomnir, P. C.
Charleston, West Virginia
Attorneys for Amici Curiae
West Virginia Oil and Natural Gas Association
and West Virginia Independent Oil and Gas
Association
Michael J. Hammond, Esq.
Dodaro, Matta & Cambest, P. C.
Canonsburg, Pennsylvania
Attorney for Amicus Curiae Bounty Minerals, LLC
CHIEF JUSTICE LOUGHRY delivered the Opinion of the Court.
JUSTICE WORKMAN concurs and reserves the right to file a concurring opinion.
JUSTICE DAVIS dissents and reserves the right to file a separate opinion.
SYLLABUS BY THE COURT
1. “‘A de novo standard is applied by this court in addressing the legal
issues presented by certified question from a federal district or appellate court.’ Syl. Pt. 1,
Light v. Allstate Ins. Co., 203 W.Va. 27, 506 S.E.2d 64 (1998).” Syl. Pt. 2, Aikens v. Debow,
208 W.Va. 486, 541 S.E.2d 576 (2000).
2. “Where the issue on an appeal . . . is clearly a question of law or
involving an interpretation of a statute, we apply a de novo standard of review.” Syl. Pt. 1,
in part, Chrystal R.M. v. Charlie A.L., 194 W.Va. 138, 459 S.E.2d 415 (1995).
3. “The primary rule of statutory construction is to ascertain and give
effect to the intention of the Legislature.” Syl. Pt. 8, Vest v. Cobb, 138 W.Va. 660, 76
S.E.2d 885 (1953).
4. “Judicial interpretation of a statute is warranted only if the statute is
ambiguous and the initial step in such interpretative inquiry is to ascertain the legislative
intent.” Syl. Pt. 1, Ohio County Comm’n v. Manchin, 171 W.Va. 552, 301 S.E.2d 183
(1983).
5. “Where the language of a statute is free from ambiguity, its plain
meaning is to be accepted and applied without resort to interpretation.” Syl. Pt. 2, Crockett
v. Andrews, 153 W.Va. 714, 172 S.E.2d 384 (1970).
i
6. “When a statute is clear and unambiguous and the legislative intent is
plain, the statute should not be interpreted by the courts, and in such case it is the duty of
the courts not to construe but to apply the statute.” Syl. Pt. 5, State v. General Daniel
Morgan Post No. 548, V.F.W., 144 W.Va. 137, 107 S.E.2d 353 (1959).
7. “The basic and cardinal principle, governing the interpretation and
application of a statute, is that the Court should ascertain the intent of the Legislature at the
time the statute was enacted, and in the light of the circumstances prevailing at the time of
the enactment.” Syl. Pt. 1, Pond Creek Pocahontas Co. v. Alexander, 137 W.Va. 864, 74
S.E.2d 590 (1953).
8. Royalty payments pursuant to an oil or gas lease governed by West
Virginia Code § 22-6-8(e) (1994) may be subject to pro-rata deduction or allocation of all
reasonable post-production expenses actually incurred by the lessee. Therefore, an oil or
gas lessee may utilize the “net-back” or “work-back” method to calculate royalties owed
to a lessor pursuant to a lease governed by West Virginia Code § 22-6-8(e). The
reasonableness of the post-production expenses is a question for the fact-finder.
ii
LOUGHRY, Chief Justice:
This case is before the Court upon certified questions presented by the
United States District Court for the Northern District of West Virginia regarding whether
this Court’s decision in Tawney v. Columbia Natural Resources, L.L.C., 219 W. Va. 266,
633 S.E.2d 22 (2006), has “any effect” upon whether a lessee of an oil and/or gas lease
subject to West Virginia Code § 22-6-8 (1994) may deduct post-production expenses from
the lessor’s royalty. Upon original hearing, a majority of this Court reformulated the
certified question and held that royalties paid pursuant to leases which were subject to West
Virginia Code § 22-6-8 could not be “diluted” by costs incurred downstream from the
wellhead, nor could amounts attributable to loss or beneficial use of volume be deducted
prior to calculation of royalties.
However, upon careful review of the briefs on rehearing, the appendix
record, the arguments of the parties and amici curiae,1 and the applicable legal authority,
we conclude that both the legislative intent and language utilized in West Virginia Code §
22-6-8 permits allocation or deduction of reasonable post-production expenses actually
1
The West Virginia Land and Mineral Owners’ Association, West Virginia Royalty
Owners’ Association, West Virginia Farm Bureau, National Association of Royalty
Owners, Appalachia, Lewis Maxwell Oil & Gas LLC, and Bounty Minerals, LLC.
provided amici briefs in support of the petitioners’ position. The West Virginia Oil and
Natural Gas Association and West Virginia Independent Oil and Gas Association provided
amici briefs in support of EQT’s position. The Court acknowledges and expresses its
appreciation for their submissions.
1
incurred by the lessee and more specifically permits use of the “net-back” or “work-back”
method of royalty calculation.
I. FACTS AND PROCEDURAL HISTORY
The petitioners Patrick D. Leggett, et al (hereinafter “the petitioners”) are
owners of a 75% undivided interest in the gas estate of a 2,000-acre tract in Doddridge
County. Certain wells on the property are “flat-rate” wells, i.e. wells for which the lease
provides for payment of a sum certain per well, per year. In 1982, the Legislature enacted
the predecessor of West Virginia Code § 22-6-8,2 which provides that permits for flat-rate
wells will not be issued unless the lessee swears by affidavit that it will pay the lessor no
less than one-eighth “of the total amount paid to or received by or allowed to [the lessee]
at the wellhead for the oil or gas so extracted, produced or marketed[.]” (emphasis added).
The petitioners filed suit against respondent EQT Production Company and
affiliated companies (hereinafter “EQT”)3 for underpayment of royalties, resulting from
2
The statute was originally codified at West Virginia Code § 22-4-1 (1982) and
subsequently recodified at West Virginia Code § 22B-1-8 (1985) before ultimately being
recodified a final time at West Virginia Code § 22-6-8 (1994).
3
Also named were EQT Energy, EQT Investment Holdings, EQT Gathering, and
EQT Midstream Partners. EQT explains that EQT Production is the exploration and
development company which “acquires the leases, drills the wells, and produces the gas,
and bears all of the costs of doing so.” EQT Gathering is the “midstream company,” which
“constructs and operates the gathering lines and compressors necessary to move the gas
from the wells to the interstate pipeline.” Finally, EQT Energy is the “sales company,”
which buys the gas from EQT Production and sells it to third parties. All of the claims
2
EQT’s deduction of certain costs incurred for the gathering and transporting of the gas to
the interstate pipeline. In particular, EQT takes the full price it obtains by selling the gas
at the interstate pipeline and deducts “some” of the costs (“midstream” costs or “post-
production” costs) incurred after it is extracted,4 but before it reaches the market at the
pipeline. EQT maintains that the only way to capture the statutorily-required “wellhead”
price is to utilize this so-called “net-back” or “work-back” method which deducts post-
production expenses from the sales price to duplicate the “wellhead” price. The petitioners
contend that neither West Virginia Code § 22-6-8(e) nor the common law of West Virginia
permit deduction or allocation of costs in this manner for purposes of royalty calculation.
Accordingly, the District Court certified the following questions to this Court
pursuant to the Uniform Certification of Questions of Law Act, West Virginia Code § 51-
1A-1 (1996) et seq.:
1. Does Tawney v. Columbia Natural Resources, L.L.C.,
219 W. Va. 266, 633 S.E.2d 22 (2006), which was decided
after the enactment of West Virginia Code § 22-6-8, have any
effect upon the Court’s decision as to whether a lessee of a flat-
rate lease, converted pursuant to West Virginia Code § 22-6-8,
against these defendants were dismissed in the action before the District Court, leaving
only EQT Production Company as the named defendant.
4
EQT asserts that it only deducts “some,” not all of its midstream costs. In
particular, it states that it does not make deductions for depreciation, income taxes, or return
(i.e. profit). The petitioners, however, dispute this and further assert that these costs are
payable to sister companies of EQT which makes the costs susceptible to overinflation.
The petitioners further allege that nominal sales are made to sister companies for the
purpose of reducing the petitioners’ royalties.
3
may deduct post-production expenses from his lessor’s royalty,
particularly with respect to the language of “1/8 at the
wellhead” found in West Virginia Code § 22-6-8(e)?
2. Does West Virginia Code § 22-6-8 prohibit flat-rate
royalties only for wells drilled or reworked after the statute’s
enactment and modify only royalties paid on a per-well basis
where permits for new wells or to modify existing wells are
sought, or do the provisions of West Virginia Code § 22-6-8
abrogate flat-rate leases in their entirety?5
(footnote added).
II. STANDARD OF REVIEW
This Court has consistently held that “‘[a] de novo standard is applied by this
court in addressing the legal issues presented by certified question from a federal district
or appellate court.’ Syl. Pt. 1, Light v. Allstate Ins. Co., 203 W. Va. 27, 506 S.E.2d 64
(1998).” Syl. Pt. 2, Aikens v. Debow, 208 W. Va. 486, 541 S.E.2d 576 (2000). Moreover,
“[w]here the issue on an appeal . . . is clearly a question of law or involving an interpretation
of a statute, we apply a de novo standard of review.” Syl. Pt. 1, Chrystal R.M. v. Charlie
5
Like the previous majority, this Court declines to answer the second certified
question. The previous majority found that it could “discern no claim with respect to the
older wells that were drilled prior to the statute’s enactment,” finding it therefore irrelevant
whether West Virginia Code § 22-6-8 abrogated flat-rate leases, as queried in the second
certified question. Critically, neither EQT nor the petitioners sought rehearing on the
previous majority’s conclusion that the second certified question was not dispositive and
therefore neither party fully briefed the issue on rehearing. Accordingly, we again decline
to answer the second certified question. See State ex rel. Advance Stores Co., Inc. v. Recht,
230 W. Va. 464, 468-69, 740 S.E.2d 59, 63-64 (2013) (“[T]his Court will not address a
certified question if it is not dispositive of a controlling issue in the case.”).
4
A.L., 194 W. Va. 138, 459 S.E.2d 415 (1995). With this standard of review in mind, we
proceed to the remaining certified question.
III. DISCUSSION
Upon review of EQT’s petition for rehearing, this Court determined that
substantial justice required us to revisit the prior opinion issued in this matter to ascertain
whether the previous majority had misapprehended certain points of law. See W. Va. R.
App. Proc. 25(b) (“A petition for rehearing is granted only in exceptional cases. The
petition shall . . . state with particularity the point of law or fact which in the opinion of the
petitioner the Court has overlooked or misapprehended[.]”). While an admittedly
uncommon occurrence, rehearing exists expressly for the purpose of ensuring that opinions
which are not well-founded due to misapprehension of the issues, the law, or the facts are
rectified. Justice demands this procedural remedy, which this Court has judiciously
utilized when the issues or outcome demand it. See Knotts v. Grafton City Hosp., 237 W.
Va. 169, 786 S.E.2d 188 (2016) (reversing and remanding upon rehearing after original
affirm); W. Va. Reg’l Jail & Corr. Facility Auth. v. A.B., 234 W. Va. 492, 498, 766 S.E.2d
751, 757 (2014) (stating that “public policy concerns raised by our initial opinion”
compelled rehearing); Hosaflook v. Consolidation Coal Co., 201 W. Va. 325, 329, 497
S.E.2d 174, 178 (1997) (twice granting rehearing in Human Rights Act case); Haines v.
Kimble, 221 W. Va. 266, 654 S.E.2d 588 (2007) (rehearing granted); Committee on Legal
Ethics of West Virginia State Bar v. Farber, 191 W. Va. 667, 447 S.E.2d 602 (1994)
(same); Jewell v. Maynard, 181 W. Va. 571, 383 S.E.2d 536 (1989) (same); Dadisman v.
5
Moore, 181 W. Va. 779, 384 S.E.2d 816 (1988) (same); Turner v. State Compensation
Comm’r, 147 W. Va. 145, 126 S.E.2d 379 (1962) (same); Garges v. State Compensation
Comm’r, 147 W. Va. 188, 126 S.E.2d 193 (1962) (same); Ellis v. Henderson, 142 W. Va.
824, 98 S.E.2d 719 (1957) (same); Reese v. Lowry, 140 W. Va. 772, 86 S.E.2d 381 (1955)
(same); Bailey v. Baker, 137 W. Va. 85, 70 S.E.2d 645 (1952) (same); State v. Gilliland,
51 W. Va. 278, 41 S.E. 141 (1902) (same).
As this Court has observed, reconsideration upon rehearing is often
facilitated by a more focused and clearer presentation of the arguments by the parties, who
commonly have a better understanding of the Court’s characterization of the dispositive
issues following an initial opinion. See Caperton v. A.T. Massey Coal Co., 223 W. Va.
624, 667, 679 S.E.2d 223, 266 (2008), rev’d and remanded, 556 U.S. 868 (2009) (Albright,
J., dissenting) (noting that “[t]he more narrow and focused legal arguments and supporting
facts of the rehearing process” aided in determination); A. B., 234 W. Va. at 498, 518-19,
766 S.E.2d at 757, 777-78 (stating that briefs submitted seeking rehearing compelled Court
to grant rehearing and criticizing respondent for attempting to supplement inadequate
record on rehearing to meet issues discussed in initial opinion); Haines, 221 W. Va. at 272-
73, nn.3 and 5, 654 S.E.2d at 594-95, nn.3 and 5 (discussing additional arguments and
attempts to supplement the appendix to meet issues raised in initial opinion). Oftentimes,
briefs upon rehearing pierce through any insufficiency or imprecision of argument which
may have affected the Court’s initial offering. This is particularly the case where a matter
is before the Court on the necessarily limited record often submitted upon certified
6
question. When a petition for rehearing compels the Court to conclude that the law may
have been misapprehended, neither hubris nor sanctimony should give the Court pause in
granting rehearing to correct any such error of law or fact. As Justice Frankfurter stated,
“[w]isdom too often never comes, and so one ought not to reject it merely because it comes
late.” Henslee v. Union Planters Nat’l Bank & Trust Co., 335 U.S. 595, 600 (1949)
(Frankfurter, J., dissenting).
As pertains to the question presented in this case, upon initial hearing, the
majority concluded that West Virginia Code § 22-6-8(e) contains an ambiguity which must
be construed in a manner which effectuates the “overarching remedial intent” of the statute
to “ensur[e] the future flow of adequate compensation to oil and gas landowners.” Such
construction, according to the previous majority, must not “curtail [] compensation” which
was intended to “right past wrongs” and therefore prohibits dilution of royalty payments
by post-production costs. Coupled with the common law implied covenant to market
previously recognized with respect to oil and gas leases, the majority concluded that
royalties must remain “supremely constant,” impervious to “facile downward
manipulation” by the lessee and therefore post-production costs for “gathering,
transporting, or treating” may not be deducted.6
6
The prior opinion reformulated the certified question to reach this holding and
further held that royalties paid pursuant to West Virginia Code § 22-6-8(e) may likewise
not be reduced for volume deductions. “Volume deductions” refer to that volume of gas
which is either lost or used in transport before it gets to market. The District Court’s
certified questions do not make inquiry, expressly or implicitly, regarding the propriety of
7
Upon rehearing, with all due regard to the previous majority’s consideration
of the admittedly complex and subversively entangled issues implicated in this case, we
conclude that it did, in fact, misapprehend the applicability of certain common law
principles and exceeded its charge in its interpretation of the subject statute.
A. W. Va. Code § 22-6-8 and Valuation of Royalties Prior to Deregulation
As initially outlined above, the petitioners contend that post-production costs
incurred by an oil or gas lessee may not be allocated to the lessor in calculation of the
lessor’s royalty. The petitioners maintain that West Virginia Code § 22-6-8(e)’s provision
that the lessor must be paid “one-eighth of the total amount paid to or received by or
allowed to the owner of the working interest at the wellhead” is ambiguous with respect to
payment of such costs; therefore, the statute should be construed in a manner which
maximizes its remedial purpose. To maximize its remedial purpose, the petitioners contend
that the phrase “at the wellhead” should be construed to prohibit allocation of post-
production costs to lessors. The petitioners further urge that this construction is consistent
with West Virginia’s common law purportedly aligning itself with several “marketable
deductions for volume losses; accordingly, the majority’s prior opinion was, at a minimum,
improvidently overbroad.
8
product rule” states which require the lessee to bear all post-production costs incurred until
the product is marketable.7
EQT maintains that the statute is not ambiguous since “at the wellhead” is a
very precise and definite location. However, acknowledging that federal deregulation of
the industry has altered the point of sale away from the wellhead, EQT argues that the only
way to mathematically calculate the “at the wellhead” price for which it is obligated by
statute is to utilize the “net-back” or “work-back” method. This method, as employed by
EQT, utilizes the interstate pipeline sales price and makes deductions for post-production
costs;8 the resulting figure is that upon which the royalty is paid and therefore purports to
7
West Virginia, however, has muddied the point to which costs must be borne by
the lessee by making reference to the “point of sale” in its syllabus points, which may of
course vary from the point in time in which a product becomes “marketable.” Such
inexplicable variations from the traditional rule have created widespread disillusionment
with West Virginia’s iteration of this rule as discussed more fully infra.
8
Throughout the briefing of the parties, amici curiae, and caselaw, this “cost-
bearing” is interchangeably referred to as “allocation” or “deduction” of costs from the
royalty; in other instances the “net-back” or “work-back” method of royalty calculation is
referenced. We concur with the following observation with regard to these various
characterizations of the issue:
Although the issue is commonly referred to as a “deduction of
costs” issue, it is more accurately a “work-back” issue to adjust
a downstream price to reflect an upstream value by subtracting
(deducting) from the downstream price what it cost to put the
wellhead gas in the position to fetch the downstream price.
David E. Pierce, Royalty Jurisprudence: A Tale of Two States, 49 Washburn L.J. 347, 377
n.91 (2010). Similarly, “the ‘net-back’ method does not ‘charge’ the lessor with any
expenses at all, but instead is simply a method of determining what the wellhead value of
9
“duplicate” a wellhead price. Commensurately, EQT urges the Court to join those states
which have formally adopted the “at the well” rule regarding cost allocation, which permits
pro rata allocation and/or deduction of post-production expenses as between the lessee and
lessor. With this understanding of the parties’ positions, we proceed to examine the statute
and applicable caselaw.
To place the parties’ arguments into proper context, it is first critical to
understand the purpose and operation of West Virginia Code § 22-6-8 and the change in
the marketplace for oil and gas sales resulting from what is commonly referred to within
the industry simply as “deregulation.” West Virginia Code § 22-6-8 was originally enacted
in 1982 to prohibit lessees from continuing to capitalize on older, “flat-rate” leases. The
statute explains that these leases were entered into
when the techniques by which oil and gas are currently
extracted, produced or marketed, were not known or
contemplated by the parties, nor was it contemplated by the
parties that oil and gas would be recovered or extracted or
produced or marketed from the depths and horizons currently
being developed by the well operators.
the gas would have been if there had been a market for the gas at the wellhead.” Brian S.
Wheeler, Deducting Post-Production Costs When Calculating Royalty: What Does the
Lease Provide?, 8 Appalachian J.L. 1, 29 (2008). For ease of reading, we likewise
somewhat interchangeably utilize the terms “allocation” and “deduction” of costs
throughout this opinion. However, whether referred to as cost “allocation,” “deduction,”
or use of the “net-back” method, our opinion should be read as encompassing any manner
by which the lessee make allowances for its cost expenditures in calculating the lessor’s
royalty.
10
W. Va. Code § 22-6-8(a)(3). The Legislature then declared that the statute was enacted
because
continued exploitation of the natural resources of this state in
exchange for such wholly inadequate compensation is unfair,
oppressive, works an unjust hardship on the owners of the oil
and gas in place, and unreasonably deprives the economy of
the State of West Virginia of the just benefit of the natural
wealth of this State[.]
W. Va. Code § 22-6-8(a)(2). Recognizing, apparently, that invalidating such leases
altogether may run afoul of the Constitution, 9 the Legislature set out to lawfully
“discourage . . . the production and marketing of oil and gas” under such leases. W. Va.
Code § 22-6-8(a)(4). Accordingly, to avoid unconstitutionally impairing the contractual
obligation, the statute simply prohibits the issuance of permits under such leases.
Subsection (d) therefore provides:
[N]o such permit shall be hereafter issued for the drilling of a
new oil or gas well, or for the redrilling . . . of an existing oil
or gas production well, where or if the right to extract, produce
or market the oil or gas is based upon a lease or leases or other
continuing contract or contracts providing for flat well
royalty[.]
W. Va. Code 22-6-8(d). To avoid this prohibition, a permit applicant must file an affidavit
certifying that it will
9
The statute expressly states that the Legislature is “fully cognizant [of] the
provisions of section 10, article I of the United States Constitution and of section 4, article
III of the Constitution of West Virginia, proscrib[ing] the enactment of any law impairing
the obligation of a contract[.]” W. Va. Code § 22-6-8(a)(4); see U.S. Const. art. I, § 10, cl.
1 (“No State shall . . . pass any Bill of Attainder, ex post facto Law, or Law impairing the
Obligation of Contracts . . .”); W. Va. Const. art. III, § 4 (“No bill of attainder, ex post facto
law, or law impairing the obligation of a contract, shall be passed.” ).
11
tender to the owner of the oil or gas in place not less than one
eighth of the total amount paid to or received by or allowed to
the owner of the working interest at the wellhead for the oil or
gas so extracted, produced or marketed before deducting the
amount to be paid to or set aside for the owner of the oil or gas
in place, on all such oil or gas to be extracted, produced or
marketed from the well.
W. Va. Code § 22-6-8(e) (emphasis added). In short, to get a permit to re-drill wells
governed by a flat-rate lease, the lessee must agree to pay the lessor a one-eighth royalty
instead of a flat rate.
The parties are in agreement that when West Virginia Code § 22-6-8 was
enacted, oil and gas sales occurred “at the wellhead,” i.e. at the point where the product
first emerges from the ground or literally, the head of the well. Interstate pipeline operators
purchased the product and undertook the expense of preparing the oil or gas for sale at
market in a useable or “marketable” form. In 1978, Congress began to “deregulate” the
natural gas market, which turned interstate pipeline operators into common carriers.10 As
10
As succinctly explained by the Colorado Appellate Court:
Congress took a first step toward increasing competition in the
natural gas market by enacting the Natural Gas Policy Act of
1978, 15 U.S.C. § 3301, et seq., which was designed to phase
out regulation of wellhead prices charged by producers of
natural gas, and to promote gas transportation by interstate and
intrastate pipelines for third parties. Pipelines were reluctant to
provide common carriage, however, when doing so would
displace their own sales.
Thus, in 1985, the Federal Energy Regulatory Commission
(FERC) promulgated Order No. 436, which contained an
12
a result, oil and gas are no longer sold “at the wellhead,” but rather are sold downstream of
the wellhead, typically at the interstate pipeline. Importantly, one of the effects of this
change is that the sales price is enhanced from the wellhead price because it is now a
marketable, useable product when it is first sold at market, rather than the raw, “sour” gas
which was sold from the wellhead. 11 However, as a result, expenses to “clean” or
“open access” rule providing incentives for pipelines to offer
gas transportation services.
In 1992, this evolution culminated in FERC’s Order No. 636,
which required all interstate pipelines to “unbundle”
transportation services from their own natural gas sales and to
provide common carriage services to buyers from other
sources that wished to ship gas. This implementing regulation
dramatically changed the natural gas industry, because pipeline
companies were “no longer permitted . . . to act as traditional
merchants—buying gas at the wellhead and reselling the gas
downstream—producers had to now market the gas
themselves.”
The deregulation of the natural gas industry is considered the
major catalyst for the current wave of royalty litigation
because, before deregulation, buyers purchased gas at or near
the wellhead, thereby absorbing most post-wellhead costs.
Now, most gas is purchased away from the wellhead.
Clough v. Williams Prod. RMT Co., 179 P.3d 32, 35 (Colo. Ct. App. 2007) (citations
omitted).
11
“To make the sour gas into sweet gas, which is a usable marketable product,
[impurities] are extracted from the sour gas.” Bice v. Petro-Hunt, L.L.C., 768 N.W.2d 496,
500 (N. D. 2009). As the court further explained in Garman v. Conoco, Inc., 886 P.2d 652,
653-54 (Colo. 1994), with respect to costs potentially incurred in the post-production
phase, as a result of the marketplace moving away from the wellhead:
Gas may require processing to remove impurities for
marketing, and once marketable may be further processed into
13
“sweeten” the gas, gather and/or compress the gas, and transport the gas are incurred after
it is extracted but before it is sold, i.e. “post-production” costs. This case presents the issue
of whether the lessee must bear all such post-production expenses or whether it may pro-
rata allocate them to the lessor and deduct them from the royalty paid by operation of West
Virginia Code § 22-6-8(e). The parties’ briefing indicates that they believe that implicit
within that query is whether this Court will apply its previously-articulated common-law
version of the “marketable product rule” or adopt the “at the well” rule of cost allocation.
B. Wellman v. Energy Resources, Inc. and Tawney v. Columbia Natural Resources
To determine the applicability of either of these schools of thought to the
statute at issue, it is necessary to examine West Virginia’s common law as pertains to
allocation of costs in an oil and gas lease. As noted above, the District Court phrased the
certified question in terms of whether Tawney v. Columbia Natural Resources has “any
effect” upon the determination of whether use of the phrase “at the wellhead” in West
additional component products. Transportation is required
when gas is moved from the wellhead to a central location to
prepare it for transmission and consumption, commonly
referred to as gathering. If no market for the gas exists near the
wellhead, transportation may be required to move the gas to a
distant market. Compression may be required to create
sufficient pressure for the gas to enter a purchaser’s pipeline,
or compression may occur to transform the gas into additional
products.
(citations omitted). See also Rogers v. Westerman Farm Co., 29 P.3d 887 (Colo. 2001) as
modified on denial of reh’g (Aug. 27, 2001) (discussing necessity of dehydration and
compression of “raw gas” and specifications of interstate pipeline).
14
Virginia Code § 22-6-8 permits allocation and deduction of post-production costs before
calculation of royalties. The petitioners urge that both Tawney and its predecessor,
Wellman v. Energy Resources, Inc., 210 W. Va. 200, 557 S.E.2d 254 (2001), firmly
establish West Virginia as a “marketable product” rule state, which rule provides that the
implied duty to market requires the lessee to bear all costs until the product is rendered
“marketable.” EQT, however, maintains that both Wellman and Tawney are inapplicable
to the statute at issue and urge an interpretation which mirrors the “at the well” rule,
permitting use of the “net-back” method to calculate royalties “at the wellhead.” We will
examine each case in turn.
Despite the District Court and parties’ pre-emptive focus on Tawney, it is
Wellman which forms the foundation of the current state of West Virginia’s law on
deduction of post-production costs. In Wellman, the Court addressed an action brought by
the lessors seeking termination of certain oil and gas leases and damages for failure to pay
proper royalties. Id. at 204, 557 S.E.2d at 258. The leases provided for natural gas royalties
of “‘one-eighth (1/8) of the market value of such gas at the mouth of the well[.]’” Id. The
lessee deducted “certain expenses” before calculating royalties. Id. at 209, 557 S.E.2d at
263. In resolving the question of whether such expenses were properly deductible, the
Court noted the widely adopted position that “costs of discovery and production” are not
chargeable against a royalty. Id. at 210, 557 S.E.2d at 264. The Court then stated that “[i]n
spite” of this position, oil and gas producers had begun deducting costs for transporting
15
and “treating or altering” the oil and gas after it is “produced” to put it into marketable
condition. Id.
The Wellman Court briefly acknowledged the split of authority regarding
deduction of such post-production costs and discussed the rationale of those states holding
that such costs are not properly deductible from the lessor’s royalty. Id. at 210, 557 S.E.2d
at 264. The Court noted that pursuant to the implied covenant to market,12 such “duty to
market embraces the responsibility to get the oil or gas in marketable condition and actually
transport it to market.” Id. Noting simply that like other marketable product rule states,
“West Virginia holds that a lessee impliedly covenants that he will market oil or gas
produced[,]” the Court quickly concluded that “unless the lease provides otherwise, the
lessee must bear all costs incurred in exploring or, producing, marketing, and transporting
the product to the point of sale.” Id. at 211, 557 S.E.2d at 265, Syl. Pt. 4.13 The Court then
12
“Implied covenants are unwritten promises by one of the parties to a contract.”
John S. Lowe, Interpreting The Royalty Obligation: The Role Of The Implied Covenant To
Market, 2003-1 RMMLF-INST 6 (2003). “The [implied covenant to market] requires that
the lessee exercise reasonable diligence to market the products, defined as ‘whatever, in
the circumstances, would be reasonably expected of all operators of ordinary prudence,
having regard to the interests of both lessor and lessee.’” Rogers, 29 P.3d at 903 (citing
Davis v. Cramer, 808 P.2d 358, 361 (Colo. 1991)). Courts and commentators alike
disagree about the scope of the implied duty and its application. See n.15, infra.
13
Notably, the Court never utilized the term “marketable product” in Wellman or
Tawney, for that matter. In fact, aside from its basic premise, the holding articulated in
Wellman bears little resemblance to the fully-formed marketable product rules adopted by
other such states. Rather than the “point of sale” referenced in Wellman, other courts
adopting the “marketable product rule” have held that costs need not be shared until a
“marketable” product is obtained:
16
Absent express lease provisions addressing allocation of costs,
the lessee’s duty to market requires that the lessee bear the
expenses incurred in obtaining a marketable product. Thus, the
expense of getting the product to a marketable condition and
location are borne by the lessee. Once a product is marketable,
however, additional costs incurred to either improve the
product, or transport the product, are to be shared
proportionately by the lessor and lessee. All costs must be
reasonable.
Rogers, 29 P.3d at 906 (emphasis added). Additionally, the Rogers court explained that
[g]as 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.
Id. at 906. Further illustrating the factual complexities which are implicated in determining
whether expenses are deductible in a “marketable product” state, the Kansas Supreme
Court held in a case where gas was sold at the wellhead that “the duty to make gas
marketable is satisfied when the operator delivers the gas to the purchaser in a condition
acceptable to the purchaser in a good faith transaction.” Fawcett v. Oil Producers, Inc. of
Kansas, 352 P.3d 1032, 1042 (Kan. 2015). See also Mittelstaedt v. Santa Fe Minerals,
Inc., 954 P.2d 1203, 1208 (Okla. 1998) (“When the gas is shown by the lessee to be in a
marketable form at the well the royalty owner may be charged a proportionate expense of
transporting that gas to the point of purchase. The lessee bears the burden of showing that
such cost is reasonable, and that actual royalty revenues increased in proportion with the
costs assessed against the nonworking interest.” (citations omitted)).
Moreover, the term “post-production costs” encompasses a myriad of expenses
potentially incurred in the process. For instance, in Garman, the court found only that
those post-production costs incurred to create a marketable product were exclusively borne
by the lessee, but that any costs which “enhance[d] the value of an already marketable
product” were assessable to the lessor. 886 P.2d at 661. Cf. Sternberger v. Marathon Oil
Co., 894 P.2d 788 (1995) (recognizing operator’s general duty to prepare gas for market
and distinguishing transportation costs from compression costs required to make gas
marketable). See n.11, supra regarding variety of potential costs involved in natural gas
processing. As an additional consideration, “natural gas must meet certain quality
17
went a step further, holding that where the lease provides for apportionment of any such
costs, they must be “actually incurred” and “reasonable.” Syl. Pt. 5, Wellman, 210 W. Va.
200, 557 S.E.2d 254.
With Wellman as background, we therefore turn to the Tawney decision to
ascertain the scope and import of its holdings. Tawney answered a certified question
tantalizingly similar to the instant certified question which inquired whether an oil and gas
lessee must “bear all costs incurred in marketing and transporting” the product where the
lease states that royalties are to be calculated “at the well,” or “at the wellhead[.]” 219 W.
Va. at 268, 633 S.E.2d at 24. Respondent Columbia Natural Resources (“CNR”) sought to
take monetary deductions for post-production costs as well as volume deductions14 before
calculating the landowners’ royalty on the involved leases. Id. at 269, 633 S.E.2d at 25.
As in this case, CNR argued that since gas is not sold at the wellhead, “the only logical
way to calculate royalties at the wellhead is to permit lessees to deduct the lessors’
specifications before it can enter an interstate gas pipeline and it must be processed to
achieve those specifications.” Fawcett, 352 P.3d at 1035.
As is clear from their holdings, these cases developed guiding principles regarding
not only the “point of sale” (i.e. is there a point of sale available other than where the oil/gas
was actually sold and did the costs increase the revenue proportionately?) and
“marketability” (i.e. was the gas in its natural state at the wellhead capable of being sold
and when was a “marketable” product achieved?), but also the type of costs (i.e. costs for
dehydrating and compressing, as compared to gathering and transporting) which were
incurred quite thoroughly. Neither Wellman nor Tawney dignify these issues, much less
develop them, despite the fact that such considerations give substance and equity to the
rule.
14
See n.6, supra regarding volume deductions.
18
proportionate share of post-production expenses[.]” Id. at 270, 633 S.E.2d at 26. The
Tawney Court accepted, without further analysis, Wellman’s reliance on the implied duty
to market and resultant holding that a lessee must “bear all costs incurred in exploring for
producing, marketing, and transporting the product to the point of sale[.]” Id. at 272, 633
S.E.2d at 28 (quoting Syl. Pt. 4, Wellman, 210 W. Va. 200, 557 S.E.2d 254). The Court
then narrowed the issue to whether the leases’ “at the wellhead” language was sufficient to
alter this “generally recognized rule.” Tawney, 219 W. Va. at 272, 633 S.E.2d at 28.
The Tawney Court found the “at the wellhead” language ambiguous because
it was “imprecise” and did not “indicate how or by what method the royalty is to be
calculated or the gas is to be valued.” Id. at 272, 633 S.E.2d at 28 (emphasis in original).
Having found such language ambiguous, the Court noted the absence of language
evidencing “an intent by the parties to agree to a contrary rule” and stated that if CNR
desired to pro-rate expenses with the landowners, it “could have written into the leases
specific language which clearly informed the lessors exactly how their royalties were to be
calculated and what deductions were to be taken from the royalty amounts for post-
production expenses.” Id. at 272, 274, 633 S.E.2d at 28, 30. Citing the “‘general rule as
to oil and gas leases . . . that such contracts will generally be liberally construed in favor of
the lessor, and strictly as against the lessee,’” the Court then construed the lease against
CNR and held that the “at the wellhead” language was insufficient to allow deduction of
post-production expenses. Id. at 273, 633 S.E.2d at 29 (quoting Syl. Pt. 1, Martin v.
Consolidated Coal & Oil Corp., 101 W. Va. 721, 133 S.E. 626 (1926)). Resting entirely
19
on the premise that CNR could simply have negotiated for and/or included in their leases
language regarding cost allocation, the Court issued the following syllabus point setting
forth the criteria for expressing such an intention in an oil and gas lease:
Language in an oil and gas lease that is intended to
allocate between the lessor and lessee the costs of marketing
the product and transporting it to the point of sale must
expressly provide that the lessor shall bear some part of the
costs incurred between the wellhead and the point of sale,
identify with particularity the specific deductions the lessee
intends to take from the lessor’s royalty (usually 1/8), and
indicate the method of calculating the amount to be deducted
from the royalty for such post-production costs.
Syl. Pt. 10, Tawney, 219 W. Va. 266, 633 S.E.2d 22.
C. Applicability of Tawney to West Virginia Code § 22-6-8(e)
Having examined Tawney, we turn now to the District Court’s first certified
question. At first blush, it would appear that the District Court’s first certified question is
unnecessarily restrictive to reach the issue of whether post-production costs may be
properly allocated under the language of West Virginia Code § 22-6-8(e), in that it asks
merely whether Tawney has “any effect” on this determination. Upon further
consideration, however, the District Court’s question demonstrates an awareness of and
subtly highlights the problematic nature of blind application of Tawney’s deceptively “on-
point” holding. As noted above, both Wellman and Tawney involved the leasing parties’
use of the term “at the wellhead” in their freely-negotiated leases. Accordingly, those
Courts were free to utilize common law principles pertaining to oil and gas leases and
contracts generally—the implied covenant to market and construction of a contract against
20
the drafter, respectively—to interpret the lease and resolve the issue. Utilizing these
common law principles to interpret a statute, however, is not legally sound. See Kilmer v.
Elexco Land Servs, Inc., 990 A.2d 1147, 1155 (Pa. 2010) (recognizing states adopting
marketable product rule “have done so as a matter of common law in interpreting
ambiguities in leases, not through statutory interpretation of a preexisting statute.”).
First, as a paramount matter, the rules of statutory construction are
considerably different than the rules of contract interpretation.
The legal standards applicable to issues of statutory
interpretation have evolved separately from those involving
matters of contract interpretation. Thus, despite the fact that . .
. statutory and contractual language are essentially identical, it
is theoretically possible that the application of each set of legal
standards would yield divergent results . . . . For example, the
legislature may have intended the statutory language to have a
different meaning than the one contemplated by the contracting
parties, even though the contract’s drafters may have merely
parroted the language of the existing statute.
Major Oldsmobile, Inc. v. Gen. Motors Corp., No. 93-Civ-2189 (SWK), 1995 WL 326475,
at *4 (S.D.N.Y. May 31, 1995), aff’d, 101 F.3d 684 (2d Cir. 1996); see Ford Motor Co. v.
Meredith Motor Co., No. CIV. 99-456-B, 2000 WL 1513702, at *5 (D.N.H. Aug. 24,
2000), overruled on other grounds as recognized in Colonial Imports Corp. v. Volvo Cars
of N. Am., Inc., No. CIV. 98-342-B, 2001 WL 274808, at *1 (D.N.H. Jan. 9, 2001)
(“Statutory interpretation differs from the interpretation of contract language.”).
Obviously, a statute cannot be “construed against” a party. On a more fundamental level,
however, the flaw in applying caselaw involving freely negotiated leases to interpret the
21
statutory language at issue is that the parties bound by the statute had no hand in its terms
or negotiation. The language choice—“at the wellhead”—was that of the Legislature.
West Virginia and other courts applying the marketable product rule to prohibit post-
production cost allocation, justify its imposition by recognizing that parties entering into a
lease may expressly provide for the allocation of costs in an effort to evade the imposition
of a common law rule. See Syl. Pt. 4, in part, Wellman, 210 W. Va. 200, 557 S.E.2d 254
(“. . . [U]nless the lease provides otherwise, the lessee must bear all costs incurred in
exploring for producing, marketing, and transporting the product to the point of sale.”
(emphasis added)); Syl. Pt. 10, in part, Tawney, 219 W. Va. 266, 633 S.E.2d 22 (“Language
in an oil and gas lease that is intended to allocate between the lessor and lessee the costs of
marketing the product and transporting it to the point of sale must expressly provide that
the lessor shall bear some part of the costs incurred . . .” (emphasis added)); Wood v. TXO
Production Corp., 854 P.2d 880, 883 (Okla. 1992) (“If a lessee wants royalty owners to
share in compression costs, that can be spelled-out in the oil and gas lease. Then, a royalty
owner can make an informed economic decision . . .”). A lessee subject to West Virginia
Code § 22-6-8 obviously has no opportunity to “expressly provide” otherwise.
Moreover, other courts have recognized that, in addition to making express
provisions for costs, freely negotiating parties to a lease may limit the implied covenants
which may append to such leases. See Garman, 886 P.2d at 664 (“The parties to an oil and
gas lease, may, by express agreement in the lease, limit the covenants implied in the lease.”)
(Erickson, J., concurring). Like express provisions for cost allocations, a lessee subject to
22
West Virginia Code § 22-6-8 has no opportunity or ability to expressly disclaim any such
implied covenants. Further, the implied covenant to market does not append itself to
statutes; rather, it is a tool utilized to resolve contractual ambiguities. Implied covenants
have been frequently referred to as contractual “gap-fillers” utilized to implement the
parties intentions where not otherwise stated: “Implied covenants, as the authorities say,
are only justified on grounds of legal necessity, and to effectuate the purposes of the
contract.” Allen v. Colonial Oil Co., 92 W. Va. 689, 115 S.E. 842, 844 (1923). 15
15
Furthermore, the use of the implied covenant to market to reach the issue of cost
allocation is highly questionable. While there is little question that it is uniformly
recognized that a lessee has an implied duty to make a reasonable effort to market gas,
several courts have concluded “that duty does not extend beyond ‘sell[ing] the gas at a
reasonable price at the well side.’” Baker v. Magnum Hunter Prod., Inc., 473 S.W.3d 588,
595 (Ky. 2015) (quoting Rains v. Kentucky, 255 S.W.121, 125 (Ky. 1923)); see also
Heritage Resources, Inc., v. NationsBank, 939 S.W.2d 118, 129 (Texas 1996) (Owen, J.,
concurring) (finding that implied duty to market cannot override express agreement
evidenced by use of term “at the well”); Owen L. Anderson, Royalty Valuation: Should
Royalty Obligations Be Determined Intrinsically, Theoretically, or Realistically? Part 2,
37 Nat. Resources J. 611, 693 n.89 (1997) (“[T]he implied covenant to market has grown
like Topsy. Arguably, it should be confined to its original purpose: to require the lessee to
diligently seek a market for gas reserves that are shut-in.”).
Nevertheless, the petitioners argue that since the Legislature is presumed to be
aware of all existing common law, it was aware of West Virginia’s recognition of the
implied covenant to market and therefore intended that the lessee bear all post-production
costs. “[T]he Legislature is presumed to be aware of the common law underlying particular
areas of legislation.” Thomas v. McDermitt, 232 W. Va. 159, 165, 751 S.E.2d 264, 270
(2013). Arguably, the Legislature may certainly be presumed to have been aware of the
implied covenant to market when the statute was enacted in 1982. However, it is wholly
unreasonable to infer that it would or should be aware of the Wellman and Tawney Courts’
subsequent broadening of the covenant as a tool to prohibit post-production cost allocation
approximately twenty years later.
23
Accordingly, the implied covenant to market relied upon by the Wellman and Tawney
Courts has no application as pertains to leases affected by West Virginia Code § 22-6-8.
In this instance, at the times these leases were executed, the parties
contemplated neither the marketing of the product and any implied covenants thereof, nor
cost allocation because the leases were flat-rate leases. The lessor’s royalty issued
irrespective of production, making post-production costs and the marketing efforts of the
lessor irrelevant to both parties for purposes of the lease. Only by operation of West
Virginia Code § 22-6-8(e), then, is cost allocation implicated in the parties’ dealings.
Accordingly, without the commensurate ability to bargain about allocation of costs or limit
any implied covenants which may affect cost-bearing, utilizing cases which are premised
on these considerations is of limited utility at best and inequitable at worst. Dogmatic
imposition, therefore, of West Virginia’s so-called marketable product rule— which was
developed upon these considerations—to prohibit allocation of post-production expenses
as requested by the petitioners yields little parity when the parties were not free to contract
otherwise.
Moreover, use of this Court’s cases involving freely negotiated contracts—
which were decided years after the statute at issue was enacted—to foster a reading of the
statute which affects the terms of a contract regarding matters which were not within the
contemplation of the parties is potentially problematic on a constitutional level. This Court
has stated that “those who enter into contracts do so with reference to the law as it exists at
24
the date thereof; and any impairment by legislative action, or otherwise, of an obligation
thus created, is plainly inhibited by both the State and Federal Constitutions.” McClintic
v. Dunbar Land Co., 127 W. Va. 454, 461, 33 S.E.2d 593, 596 (1945). While West Virginia
Code § 22-6-8 itself is cognizant of the delicate balancing act it undertakes to avoid
unconstitutionally impairing contractual rights by affecting only the issuance of permits,
extending the statute beyond that procedural prerequisite into the terms of the negotiated
lease between the parties is dangerous territory. See n.9, supra. In interpretation of a
statute, it is not for this Court to attempt to “retrofit” this Court’s caselaw to give meaning
to a statute enacted well before such precedent, particularly when such precedent employs
a rationale wholly inapplicable to statutory construction and so substantially affects the
contracting parties’ rights. We therefore conclude that neither Wellman nor Tawney are
applicable to an analysis of the “at the wellhead” language contained in West Virginia Code
§ 22-6-8(e).
Before leaving our discussion of Wellman and Tawney, however, we are
compelled to further illustrate the faulty legs upon which this precedent and its iteration of
the marketable product rule purports to stand. Commentators have noted that Wellman
failed to “recognize the variations in the first marketable product doctrine from state to
state” and “whether intentionally (as a result of its apparent antagonism against oil and gas
producers) or unintentionally (as a result of its cursory review of the case law) . . . adopted
yet another version of the first marketable product doctrine[.]” Byron C. Keeling &
25
Karolyn King Gillespie, The First Marketable Product Doctrine: Just What Is the
“Product”?, 37 St. Mary’s L.J. 1, 77, 79 (2005). Moreover, Wellman’s
“point of sale” approach results in an even bigger windfall for
lessors than the “marketable product” approach. Under the
“point of sale” approach, a lessor will not only receive a royalty
valued upon the gas in its natural state at the wellhead or when
the gas becomes marketable, but will receive a royalty valued
upon the gas in its processed state at the point of sale after the
gas has had value added to it solely at the lessee’s expense.
Wheeler, supra at 27-28. The Wellman and Tawney Courts’ refusal to align with other
states which have more fully developed this rule has, according to these commentators,
created “chaos” and “foster[s] the belief—perhaps the reality—that the [marketable
product] doctrine lacks any cornerstone principles[.]” Keeling & Gillespie, supra at 79,
80.
More importantly, still other commentators have observed that “West
Virginia has actually achieved a Marketable Product Rule result that seems to arise more
from an unwillingness to accept the realities of deregulation in the natural gas market than
from implied covenant law.” John W. Broomes, Waste Not, Want Not: The Marketable
Product Rule Violates Public Policy Against Waste of Natural Gas Resources, 63 U. Kan.
L. Rev. 149, 170–71 (2014). As support for this proposition, authors have cited to
Wellman’s and Tawney’s dogged devotion to Professor Donley’s, pre-deregulation 1951
treatise “The Law of Coal, Oil and Gas in West Virginia and Virginia.” Additionally, citing
Tawney’s stinging criticism that the lessee in that case did not even begin deducting costs
26
until 1993, one author uses this statement to establish the Tawney Court’s complete
misunderstanding of the industry:
The problem with this observation [that the lessee did not
deduct costs until 1993] is that the lessee would not have
incurred post-production costs prior to 1993 because the
pipeline company would most likely have been purchasing gas
at the wellhead for a price that reflected the gathering,
dehydration, compression, treating, processing, line loss, and
other investments associated with the gas as it moved from the
wellhead to the point of sale.
Pierce, supra at 368.
In sum, this Court’s jurisprudence on this issue has been critically described
as follows:
If one believes the language has a role to play in defining the
lessee’s rights and obligations under the oil and gas lease, then
the artful approach[] of the . . . West Virginia court[] [is]
nothing more than a re-writing of the parties’ contract to take
money from the lessee and give it to the lessor.
Id. at 374. The foregoing notwithstanding, however under-developed or inadequately
reasoned this Court observes Wellman and Tawney to be, the issue presently before the
Court simply does not permit intrusion into these issues. We therefore leave for another
day the continued vitality and scope of Wellman and Tawney.
D. Interpretation of “At the Wellhead” as used in West Virginia Code § 22-6-8(e)
27
The foregoing leads us inexorably to the conclusion that West Virginia Code
§ 22-6-8(e) must therefore be applied and/or interpreted without regard to the policy-driven
issues of whether West Virginia is or should be a “marketable product” state as
contemplated in Wellman and Tawney, or should adopt the “at the well” rule. Just as we
reject Wellman and its progeny as dispositive of the statutory issues presented herein, we
must likewise reject the implicit entreaties of the parties and amici curia to make “good”
policy choices in our interpretation of the language of West Virginia Code § 22-6-8(e).
The touchstone of the issue presented by the District Court is strictly one of statutory
interpretation and we are thus bound by our well-established and extensive canons in that
regard. Accord Kilmer, 990 A.2d 1147 (rejecting adoption of competing rules of post-
production cost deduction in favor of statutory interpretation).
1. Legislative Intent
As this Court has long-recognized, “[t]he primary rule of statutory
construction is to ascertain and give effect to the intention of the Legislature.” Syl. Pt. 8,
Vest v. Cobb, 138 W. Va. 660, 76 S.E.2d 885 (1953). “Judicial interpretation of a statute
is warranted only if the statute is ambiguous and the initial step in such interpretative
inquiry is to ascertain the legislative intent.” Syl. Pt. 1, Ohio County Comm’n v. Manchin,
171 W. Va. 552, 301 S.E.2d 183 (1983). Moreover, “[i]t is important to note that, if the
legislative intent is clearly expressed in the statute, this Court is not at liberty to construe
the statutory provision, but is obligated to apply its plain language.” Dan’s Carworld, LLC
v. Serian, 223 W. Va. 478, 484, 677 S.E.2d 914, 920 (2009). The foregoing compels us to
28
first carefully examine the Legislature’s unusually extensive statement of purpose in the
statute at issue and consider the circumstances at the time of enactment.
As set forth at length in West Virginia Code § 22-6-8, the West Virginia
Legislature expressly sought to restore a “just” benefit to those upon whom a flat-rate lease
worked an “unfair, oppressive, [and] unjust hardship” upon mineral owners and
“unreasonably deprive[d]” the State’s economy of such benefit. W. Va. Code 22-6-8(a)(2)
(emphasis added). Critically, the statute expressly states that it seeks to bring an end to
“inadequate compensation” for the State’s natural resources. Id. (emphasis added). The
Legislature could scarcely have used more descriptive terms to convey the over-arching
goal of the statute: to ensure fair and adequate compensation for the State’s mineral
owners.
2. Statutory Language
With this intention as backdrop, we turn to the statute’s plain language. In
analyzing the meaning of a statute, “[w]e look first to the statute’s language. If the text,
given its plain meaning, answers the interpretive question, the language must prevail and
further inquiry is foreclosed.” Appalachian Power Co. v. State Tax Dep’t, 195 W.Va. 573,
587, 466 S.E.2d 424, 438 (1995); see also Syl. Pt. 2, Crockett v. Andrews, 153 W.Va. 714,
172 S.E.2d 384 (1970) (“Where the language of a statute is free from ambiguity, its plain
meaning is to be accepted and applied without resort to interpretation.”); Syl. Pt. 5, State
v. General Daniel Morgan Post No. 548, V.F.W., 144 W. Va. 137, 107 S.E.2d 353 (1959)
29
(“When a statute is clear and unambiguous and the legislative intent is plain, the statute
should not be interpreted by the courts, and in such case it is the duty of the courts not to
construe but to apply the statute.”).
The statute requires that the affidavit executed by the lessor, as a prerequisite
to re-permitting, aver that the lessor will tender to the “owner of the oil or gas in place not
less than one eighth of the total amount paid to or received by or allowed to the owner of
the working interest at the wellhead for the oil or gas so extracted, produced or marketed[.]”
W. Va. Code § 22-6-8(e). As the parties readily agree, however, the industry practice with
respect to sale of oil or gas has changed considerably due to deregulation since the time the
statute was enacted and sales no longer occur “at the wellhead.” With respect to statutes
which outlive circumstances existing at the time of enactment, this Court has held: “The
basic and cardinal principle, governing the interpretation and application of a statute, is
that the Court should ascertain the intent of the Legislature at the time the statute was
enacted, and in the light of the circumstances prevailing at the time of the enactment.” Syl.
Pt. 1, Pond Creek Pocahontas Co. v. Alexander, 137 W. Va. 864, 74 S.E.2d 590 (1953)
(emphasis added).
In consideration of the foregoing, we readily conclude that the phrase “at the
wellhead” is not ambiguous as used in West Virginia Code § 22-6-8. Despite Tawney’s
conclusion to the contrary, we disagree fully with its rationale that “at the wellhead” is
ambiguous simply because it fails to fully outline allocation of post-production costs.
30
Rather, the absence of such terms is mere silence and as this Court has repeatedly held,
“silence does not, in and of itself, render a statute ambiguous.” Griffith v. Frontier W. Va.,
Inc., 228 W. Va. 277, 285, 719 S.E.2d 747, 755 (2011). Moreover, “at the wellhead” is
not ambiguous on its face; indeed, even the parties agree that the phrase “at the wellhead”
has a very precise and definite meaning.16 See also 3 Patrick H. Martin and Bruce M.
Kramer, Williams & Meyers Oil and Gas Law § 645.2 at 614.12(14) (2016) (“If anything,
the term ‘wellhead’ is very precise and definite because it is a clearly recognizable place
which even laypersons can understand.”). Courts have likewise found the phrase easily
definable and with precise meaning. See Piney Woods Country Life Sch. v. Shell Oil Co.,
726 F.2d 225, 240 (5th Cir. 1984) (“‘At the well’ means that the gas has not been increased
in value by processing or transportation.”); Atl. Richfield Co. v. State of Cal., 262 Cal. Rptr.
683, 688 (Cal. Ct. App. 1989) (“The term ‘at the well,’ when used with reference to oil and
gas royalty valuation, is commonly understood to mean that the oil and gas is to be valued
in its unprocessed state as it comes to the surface at the mouth of the well.”); Bice, 768
N.W.2d at 502 (“[T]he term market value at the well is not ambiguous.”); Heritage
Resources, 939 S.W.2d at 129 (“The words ‘at the well’ should be given their
straightforward meaning. Market value ‘at the well’ means the value of the gas at the well,
16
The petitioners brief states: “Petitioner can agree with Respondent that the
‘wellhead’ is easily identified.” However, even if the parties were not in such agreement,
“[t]he fact that parties disagree about the meaning of a statute does not itself create
ambiguity or obscure meaning.” T. Weston, Inc. v. Mineral County, 219 W. Va. 564, 568,
638 S.E.2d 167, 171 (2006) (citing Deller v. Naymick, 176 W. Va. 108, 112, 342 S.E.2d
73, 77 (1985)).
31
before it is transported, treated, compressed or otherwise prepared for market.”); Judice v.
Mewbourne Oil Co., 939 S.W.2d 133, 136 (Tex. 1996) (“[V]alue at the well means the
value of the gas before it has been compressed and before other value is added in preparing
and transporting the gas to market.”); see also Cotiga Dev. Co. v. United Fuel Gas Co.,
147 W. Va. 484, 128 S.E.2d 626 (1962) (distinguishing between wellhead price of gas from
price received at market).
Not only is the “at the wellhead” language clearly indicative of a legislative
intention to value the royalties paid pursuant to the statute based on the unprocessed
wellhead price, we do not believe that permitting lessors to benefit from royalties based
upon an enhanced, downstream price without commensurately sharing in the expense to
create the enhanced value effectuates the “adequate” and “just” compensation sought by
the statute. Nowhere within the stated purpose did the Legislature utilize language which
enabled the “maximum benefit to landowners” construction adopted by the previous
majority. 17 As the Atlantic Richfield court observed: “This is not a case where literal
interpretation would result in absurdity, requiring adroit interpretation by a reviewing court
17
This is where we believe the previous majority most clearly missed the mark.
Caught up in the passionate and persuasive statement of legislative intent set forth in West
Virginia Code § 22-6-8, the previous majority misconstrued the intent of the Legislature to
permit an unjustifiable windfall that far exceeds the Legislative purpose of bringing an end
to “inadequate compensation” for the State’s natural resources. W. Va. Code § 22-6-
8(a)(2) (emphasis added).
32
. . . . It is [] a situation where a term was employed by the Legislature which has an
established meaning[.]”) 262 Cal. Rptr. at 689.
Our determination of this issue is particularly reinforced by the Pennsylvania
Supreme Court’s handling of a nearly identical statutory issue. In Kilmer, the court was
required to determine whether its minimum royalty statute permitted allocation or
deduction of post-production expenses. Like the instant matter, the lessor/landowners
“rel[ied] upon a century-old theory in oil and gas law placing an ‘implied duty to market’
upon gas companies[,]” which implied duty purportedly required gas companies to bear all
costs until the product reached the market. 990 A.2d at 1152. The lessor/landowners
likewise argued that the remedial “Guaranteed Minimum Royalty Act” was intended to
“prevent deception and exploitation of Pennsylvania property owners by developers[.]” Id.
at 1153. The lessor/landowners argued that the only way to ensure the statutory purpose
of landowners being paid a minimum one-eighth royalty was to require gas companies to
pay royalties on the amount received by the companies “when it sells the gas at the
prevailing market price, and not the illusory value of the gas ‘at the wellhead.’” Id. As in
the instant case, the lessor/landowners further argued that the costs the gas companies
sought to deduct were “subject to corporate manipulation and inflation[.]” Id.
Just as in the instant case, in Kilmer, the gas companies argued that the statute
required royalties paid on gas which was “removed” from the property and that the gas was
necessarily removed at the wellhead. Id. at 1154. Accordingly, they argued that they “must
33
work backward from the value-added price received at the point of sale by deducting the
companies’ costs of turning the gas into a marketable commodity” via the net-back method.
Id. The gas companies explained that since their products were sold “at various points
downstream from the wellhead in various states of production and that the further
downstream the sale, the higher the price.” Id. Critically noting that at the time the statute
was enacted, “the wellhead was the point of royalty measurement,” the gas companies
argued that the net-back method “merely recreates the allocations that existed at the time
the [statute] was enacted[.]” Id. at 1155.
Faced with precisely the same arguments and called upon to interpret
whether its guaranteed minimum royalty statute permitted deduction of costs, the Kilmer
court first noted that the statute was silent on this issue. Id at 1157. The court then
concluded that “[g]iven the current state of the industry where the wellhead and the point
of sale are not the same, we are required to interpret which valuation point is most
consistent with the language of the statute.” Id. Finding that the net-back method equalizes
the royalty payable to the lessor regardless of where the “value-added” product is sold
downstream, the Kilmer court held that its statute permitted the calculation of royalties at
the wellhead utilizing the net-back method. Id. at 1158. The court dealt with the
lessor/landowners’ concerns about cost inflation by noting that “gas companies have a
strong incentive to keep their costs down, as they will be paying seven-eighths of the costs,”
but that if the lessor suspects abuse of the cost allocation he or she may pursue an action in
court. Id.; accord, Atl. Richfield, 262 Cal. Rptr. 683 (utilizing rules of statutory
34
construction to apply, rather than interpret, statute utilizing phrase “market value at the
well”).
Like the Kilmer court, it is the duty of this Court to determine precisely what
the goal of West Virginia Code § 22-6-8 was at the time it was enacted and construe it in a
fashion that most closely effectuates this purpose. While the language of West Virginia
Code § 22-6-8 differs from that of the Pennsylvania statute, the import is the same: both
were intended to guarantee a fair, minimum royalty to lessors calculated at the wellhead.
The petitioners fail to persuade us that this purpose is undermined in any fashion through
the pro-rata deduction or allocation of costs incurred to enhance the value of the oil or gas.
Further, the plain and unambiguous language of the statute has a very precise meaning
within the industry and the Legislature’s use of that language at the time the statute was
enacted clearly delineates the place of royalty valuation.
As a result, we are persuaded, as was the Kilmer court, that the most logical
way to ascertain the wellhead price is, in fact, to deduct the post-production costs from the
“value-added” downstream price in an effort to replicate the statutory wellhead value. The
Piney Woods court explained that “to adjust for imperfect comparisons[,] . . . [p]rocessing
costs may [] be deducted as an indirect means of determining what a buyer would have
paid for the sour gas at the wellhead.” 726 F.2d at 240. As the Michigan Court of Appeals
similarly observed:
Basic principles of economics require that, in determining the
“gross proceeds at the wellhead” in the absence of an actual
35
sale of gas at the wellhead resulting in ascertainable gross
proceeds, the gross proceeds from a sale elsewhere must be
extrapolated, backwards or forwards, to reflect appropriate
adjustments due to differences in the location, quality, or
characteristics of what is being sold. These principles apply to
natural gas as well as to other sales.
Schroeder v. Terra Energy, Ltd., 565 N.W.2d 887, 892 (Mich. Ct. App. 1997) (emphasis
added).
The equity of this approach is readily apparent. As the Schroeder court
explained, to allow calculation of royalties at downstream of the wellhead without
concomitant cost allocation would inequitably increase royalties “as a function of
defendant’s own efforts to enhance the value of the gas through postproduction investments
that it has exclusively underwritten.” Id. at 894. Similarly, the Kentucky Supreme Court
concluded that not only were cost deductions not in derogation of the “one-eighth at the
well” language, but that refusal to allow all such deductions would result in the landowner
receiving more than the agreed one-eighth:
If the landowner’s royalty is calculated on the amount received
by the lessee downstream minus only transportation costs, the
landowner receives more than one-eighth the value of the raw
gas produced from his property, i.e., he receives one-eighth of
the value of the processed gas, an enhanced product, without
having borne any of the costs associated with turning the raw
gas into that more valuable product. The “first marketable
product” approach, thus distorts the seven-eighths/one-eighth
split of the “market price at the well” for which the parties
contracted.
Baker, 473 S.W.3d at 595 (emphasis in original).
36
We are likewise left with the inescapable conclusion that the petitioners
herein seek to unfairly maximize their royalty payments without commensurately bearing
the cost of achieving that maximum value. With no hesitation, we conclude that the
industry-recognized “net-back” or “work-back” method of royalty calculation is equally
just to both parties and, more importantly, the closest appreciable method of effectuating
what the Legislature envisioned.
Nevertheless, the petitioners insist that the remedial nature of the statute
commands this Court to construe it in a manner which curtails the “mischief” and “evil
intended to be suppressed.” The “evil intended to be suppressed” through West Virginia
Code § 22-6-8 is the payment of flat-rate royalties, which are not volume-based—no more,
no less. Mere pro-rata allocation or deduction of post-production expenses which equally
enhance the value of the oil or gas for both the lessee and lessor is a far cry from “evil” or
“mischief,” much less the type the statute was intended to eliminate. 18 Moreover, this
18
That the petitioners characterize cost allocation as “evil” or “mischief” is
unsurprising given the precedent which bizarrely describes such legitimate business
accounting functions in a decidedly pejorative manner. As one commentator noted:
The court in Wellman and Tawney takes a surprising and rather
ill-informed view of the “net-back” method. Despite precedent
that clearly permitted lessees to use the “net-back” or “work-
back” method to calculate royalties, the court in Wellman
seemed to believe that large gas companies had developed the
“net-back” method as a sham for the purpose of cheating
lessors.
Wheeler, supra at 28–29.
37
Court long ago recognized the appropriate limitations placed upon its duty to interpret
statutory language: “The limits of the application of a statute are generally held to be
coextensive with the . . . purpose it was intended to . . . effectuate, and neither stop short
of, nor go beyond, the purpose which the Legislature had in view.” Syl. Pt. 2, City of
Charleston v. Charleston Brewing Co., 61 W. Va. 34, 56 S.E. 198 (1906). The fact that
the statute is remedial in purpose is an inadequate basis upon which to exceed its stated
goals: “[T]he breadth of a statute or the duty to construe a remedial statute liberally can
not amount to authority to a court to extend a statute to a case wholly beyond its effects.”
Henthorn v. Collins, 146 W. Va. 108, 111, 118 S.E.2d 358, 360 (1961).
Having deconstructed the first certified question to reach the issue underlying
the parties’ still-pending cause of action, we find it appropriate to reformulate it:
When a certified question is not framed so that this Court is
able to fully address the law which is involved in the question,
then this Court retains the power to reformulate questions
certified to it under both the Uniform Certification of
Questions of Law Act found in W. Va. Code, 51-1A-1, et seq.
and W. Va. Code, 58-5-2 [1967], the statute relating to certified
questions from a circuit court of this State to this Court.
Syl. Pt. 3, Kincaid v. Mangum, 189 W. Va. 404, 405, 432 S.E.2d 74, 75 (1993). We
therefore reformulate the first certified question into two questions as follows:
Are royalty payments pursuant to an oil or gas lease governed
by West Virginia Code § 22-6-8(e) (1994) subject to pro-rata
deduction or allocation of post-production expenses by the
lessee?
38
May an oil or gas lessee utilize the “net-back” or “work-back”
method to calculate royalties owed to a lessor pursuant to a
lease governed by West Virginia Code § 22-6-8?
We answer both of the reformulated questions in the affirmative.
E. Limitations on Cost Allocation or Deduction
The foregoing notwithstanding, this Court further recognizes that simply
permitting lessees to carte blanche allocate post-production costs without additional
guidance is no more satisfying or equitable than was the previous majority’s broad,
impenetrable rule prohibiting such allocation. Even courts in marketable product rule
states are concerned with potential fraud or abuse, where costs are properly deductible:
Some difficulty may arise in computing post-production
marketing costs if the operations necessary to prepare the
product for market, and operations to enhance the value of a
marketable product, occur at the same facility. When the same
company both extracts and processes the gas all operating costs
must be closely scrutinized. . . . . Such a determination is a
question of fact to be decided based on competent evidence in
the record.
Garman, 886 P.2d at 661, n. 28 (citing Amoco Production Co. v. First Baptist Church of
Pyote, 579 S.W.2d 280 (Tex. Civ. App. 1979)).19
19
Moreover, in Tara Petroleum Corp. v. Hughey, 630 P.2d 1269, 1275 (Okla. 1981),
the court cautioned that
Courts should take care not to allow lessors to be deprived or
defrauded of their royalties by their lessees entering into
illusory or collusive assignments or gas purchase contracts.
Whenever a lessee or assignee is paying royalty on one price,
39
Some limitations on the deductibility or apportionment of costs, however, do
not derive of fraud or self-dealing, but rather, the law’s unwavering requirement of
reasonableness as both a guiding and limiting factor. Despite its resistance to cost
allocation, even the Wellman Court recognized and explicitly held that where costs are
properly allocated or deducted, “the lessee must prove, by evidence of the type normally
developed in legal proceedings requiring an accounting, that he, the lessee, actually
incurred such costs and that they were reasonable.” Syl. Pt. 5, in part, Wellman. See also
Piney Woods, 726 F.2d at 241 (“[T]he processing costs . . . must be reasonable.”); Garman,
886 P.2d at 661 (“To the extent that certain processing costs enhance the value of an already
marketable product the burden should be placed upon the lessee to show such costs are
reasonable[.]”); Babin v. First Energy Corp., 693 So. 2d 813, 815-16 (La. Ct. App. 1997)
(“In addition to the character or nature of the costs deducted is the question of the
reasonableness of the amount deducted.” (emphasis in original)); Bice, 768 N.W.2d at 504
(“[W]hether a charge is commercially reasonable is a question of fact[.]”).20
but on resale a related entity is obtaining a higher price, the
lessors are entitled to their royalty share of the higher price.
The key is common control of the two entities.
20
The Babin court likewise noted that “the deductibility of any cost may be
determined with reference to its nature” and “should focus primarily on the propriety of
the deduction in light of acceptable cost accounting standards” and include “all relevant
costs.” 693 So. 2d at 815. We recognize that additional issues may arise with respect to
the propriety of certain deductions. We leave those issues to be decided upon a developed
record where such issues are properly presented. “We have traditionally maintained that
40
We therefore hold that royalty payments pursuant to an oil or gas lease
governed by West Virginia Code § 22-6-8(e) may be subject to pro-rata deduction or
allocation of all reasonable post-production expenses actually incurred by the lessee.
Therefore, an oil or gas lessee may utilize the “net-back” or “work-back” method to
calculate royalties owed to a lessor pursuant to a lease governed by West Virginia Code §
22-6-8(e). The reasonableness of the post-production expenses is a question for the fact-
finder.
As a final matter, we note the petitioners’ foreboding contention that the
resolution reached herein creates a conflict with leases which remain subject to Wellman’s
and Tawney’s prohibition on such cost allocation, save express language in the lease
permitting such allocation. The petitioners maintain that this leads to an impermissible
“inconsistent” result. See Expedited Transp. Sys., Inc. v. Vieweg, 207 W. Va. 90, 98, 529
S.E.2d 110, 118 (2000) (“It is the ‘duty of this Court to avoid whenever possible a
construction of a statute which leads to absurd, inconsistent, unjust or unreasonable
results.’” (quoting State v. Kerns, 183 W. Va. 130, 135, 394 S.E.2d 532, 537 (1990)).
However, as previously indicated, the leases at issue herein are flat-rate leases, the royalty
provisions of which have been amended by operation of West Virginia Code § 22-6-8 and
the required permitting affidavit outlined therein. The leases in Wellman and Tawney and
upon receiving certified questions we retain some flexibility in determining how and to
what extent they will be answered.” City of Fairmont v. Retail, Wholesale, & Dep’t Store
Union, AFL-CIO, 166 W. Va. 1, 3-4, 283 S.E.2d 589, 590 (1980).
41
other such leases obviously are unaffected by the statute and therefore this opinion.
Accordingly, we find no inconsistent result where two distinct types of leases of completely
differing character are involved, one type of which is the product of free and open
negotiation and the other encumbered by operation of statute. Nevertheless, this Court
recognizes the inherent tension between holders of leases subject to our interpretation of
West Virginia Code § 22-6-8 and those freely-negotiated leases which remain subject to
the holdings of Wellman and Tawney. We therefore implore the Legislature to resolve the
tensions as it sees fit inasmuch as this Court may only act within the confines of our
constitutional charge.21
IV. CONCLUSION
For the reasons set forth hereinabove, we answer the reformulated certified
questions in the affirmative.
21
In fact, we observe that a member of the House of Delegates introduced a bill in
the 2017 regular Legislative session purporting to amend West Virginia Code § 22-6-8.
The introduced bill specifically implicated the “at the wellhead” language and stated that
it was intended to “[c]larify[] the intent of gas royalty leases which required not less than
1/8th (12.5%) of the total amount paid to, received by or delivered to the owner [of the
working interest].” See H. B. 3042 (Regular Session, 2017). However, the bill appears to
have died in Committee.
42
Certified Questions Answered.
43