Hitch Enters., Inc. v. Key Prod. Co.

540 P.3d 489

HITCH ENTERPRISES, INC., on behalf of itself and others similarly situated, Plaintiff/Appellee,

v.KEY PRODUCTION COMPANY, INC., Defendant/Appellant.

Case No. 119,052

Court of Civil Appeals of Oklahoma, Division No. 4.

Filed December 30, 2022

Mandate Issued: November 16, 2023

Rex A. Sharp, Barbara C. Frankland, SHARP LAW, LLP, Prairie Village, Kansas, and Nathan K. Davis, Pro Hac Vice, SNELL & WILMER, L.L.P., Denver, Colorado, for Plaintiff/Appellee

Bradley W. Welsh, GABLE & GOTWALS, Tulsa, Oklahoma, for Defendant/Appellant

OPINION BY JOHN F. FISCHER, CHIEF JUDGE:

¶1 Key Production Company, Inc., appeals the district court's order certifying Hitch Enterprises, Inc.'s case as a class action in this natural gas royalty dispute. Hitch filed this case on behalf of itself and all similarly situated royalty owners alleging that Key had breached the implied covenant to market natural gas extracted from wells in which Class members own a royalty interest. Hitch alleges that Key wrongfully deducted certain processing costs from the proceeds Key received for selling the gas before paying the royalty owners their proportionate share of the sale proceeds. After class discovery and a hearing on Hitch's motion to certify the case as a class action, the district court found that Hitch had satisfied the statutory elements required by 12 O.S.2021 § 2023 and granted Hitch's motion. We affirm.

BACKGROUND

¶2 This case involves 386 wells located in fourteen different counties and producing from seventeen different reservoirs. The wells are located on property subject to 3,032 oil and gas leases in which Key is the lessee. More than 3,000 royalty owners, the members of the Class certified by the district court, are the lessors. Key is the operator of these wells or responsible for marketing and selling any gas extracted from the Class wells. Key sells the gas from these wells pursuant to twenty-two gas purchase contracts. Key is also responsible for paying the royalty owners their proportionate share of the sale proceeds.

¶3 Generally, a lessee, like Key, will engage in one or more of the following services necessary to transform gas produced at the well into a marketable product: gathering (G), compressing (C), dehydration (D), treatment (T), and processing (P). The industry and relevant jurisprudence commonly refer to these services as GCDTP services. However, some gas is marketable without the necessity of any of these services.

¶4 The "sole issue" in this case, as described by Key, is the proper allocation of the "expenses of extracting natural gas liquids ("NGLs") at processing plants to yield residue gas (mostly methane) and NGLs (such as ethane, propane, butane, and heavier liquid hydrocarbons)." Key charged Class members their proportionate share of these expenses. These expenses are the "processing costs" at issue in this case and which the Class members seek to recover.

¶5 Despite its 36 assignments of error, the essence of Key's appeal centers on two contentions: (1) whether processing is necessary to produce marketable gas requires a fact-intensive inquiry dependent on the quality and attributes of the gas extracted from each of the 386 Class wells; and (2) the amount Key is required to pay Class members for marketable gas depends on the terms of each of the 3,032 individual leases, over eighty different royalty clauses and twenty-two gas purchase contracts. Key argues that these issues cannot be resolved with common evidence and, therefore, individualized issues predominate. Key contends that this case is not appropriate for class treatment and the district court erred in granting Hitch's motion and certifying this Class of plaintiffs.

STANDARD OF REVIEW

¶6 The de novo standard of review controls our review of the district court's class certification order. Marshall Cnty. v. Homesales, Inc ., 2014 OK 88, ¶ 6, 339 P.3d 878 (interpreting 12 O.S. Supp. 2013 § 2023(C)(2) ). The legal conclusion that a class should or should not be certified is reviewed independently and without deference to the district court's ruling. Id . Although the same legal standard governs the decision to grant or deny class certification, the district court and the appellate court do not perform the same function. When necessary, the district court engages in "preliminary" fact-finding to resolve the certification issue. The appellate court reviews those findings pursuant to the "against-the-clear-weight-of-the-evidence" standard. Id . ¶ 7.

¶7 Nonetheless, the district court's factual determinations are only a "forecast" of the evidence that may eventually be produced at trial and not a decision on the merits of the claim. Burgess v. Farmers Ins. Co., Inc. , 2006 OK 66, ¶ 15, 151 P.3d 92. ( Burgess recognized "the rule that it is inappropriate to consider the merits of a claim" or any indication of how a jury might decide the fact questions. Id . ¶ 16. Ultimately, a class certification order "resolves only a question of law and the de novo standard required by Title 12 O.S. Supp. 2013 2023(C)(2) is appropriate for appellate review of class certification orders entered after November 1, 2009." Marshall Cnty. , 2014 OK 88, ¶ 8, 339 P.3d 878.

ANALYSIS

¶8 As noted, this case concerns the processing costs of removing natural gas liquids in conjunction with the production and sale of the gas produced by Key from the Class wells. Processing involves lowering the temperature of raw gas to remove certain liquids before the gas will be accepted into an intrastate or interstate purchaser's high-pressure transmission pipeline for ultimate sale to consumers. Key has contracted with several "midstream" companies to perform the processing required by the transmission companies for the gas extracted from the Class wells. None of these midstream companies is owned by or affiliated with Key.

¶9 The gas from each of the individual Class wells is collected through gathering systems attached to the wells and commingled with gas from other Class wells for delivery to the midstream companies' plants. After the midstream companies complete the necessary processing, the gas received from Key is delivered to the transmission pipeline companies. In general, the midstream companies pay Key the price they receive from the transmission companies after deducting the costs of processing. That net amount is the amount Key used to calculate a Class member's proportionate share of the sale price of the gas extracted from the Class member's well.

¶10 Whether Key can charge processing costs to Class members usually depends on whether the costs are necessary to transform the gas into a marketable product.

Generally, costs have been construed as either production costs which are never allocated, or post-production costs, which may or may not be allocated, based upon the nature of the cost as it relates to the duties of the lessee created by the express language of the lease, the implied covenants, and custom and usage in the industry.

Mittelstaedt v. Santa Fe Minerals, Inc ., 1998 OK 7, ¶ 26, 954 P.2d 1203. Post-production costs are not an issue in this case. Hitch contends that the midstream companies' processing fees which Key charged Class members were non-chargeable production costs and has limited its claim for damages to that contention.

I. Key's Contractual Obligation

¶11 "It is common knowledge that raw or unprocessed gas usually undergoes certain field processes necessary to create a marketable product. These field activities may include, but are not limited to, separation, dehydration, compression, and treatment to remove impurities." Id. ¶ 21. In Oklahoma, a lessee in Key's position is subject to a covenant implied in its lease by law to provide, at the lessee's expense, any of the field services necessary to transform gas extracted from the well into a marketable product. " ‘[T]he implied duty to market means a duty to get the product to the place of sale in marketable form.’ " Id. ¶ 12 (quoting TXO Prod. Corp. v. State ex rel. Comm'rs of Land Office , 1994 OK 131, ¶ 11, 903 P.2d 259 ). What is required to transform gas extracted from the Class wells into a marketable product is a central issue in this case.

¶12 Oklahoma case law has established that "the costs for compression, dehydration and gathering are not chargeable to [royalty owners] because such processes are necessary to make the product marketable under the implied covenant to market." TXO Prod. Corp. , 1994 OK 131, ¶ 17, 903 P.2d 259 ; see also Mittelstaedt , 1998 OK 7, ¶¶ 24-29, 954 P.2d 1203. Transportation costs may or may not be chargeable to royalty owners depending on whether there is a market for the gas "available at the lease." Id. ¶ 13 (explaining and discussing Johnson v. Jernigan , 1970 OK 180, 475 P.2d 396 ).

¶13 Key has not charged Class members for compression, dehydration, gathering or transportation costs. Post-production "excess" services used to enhance marketable gas are not at issue in this case. Id. ¶ 26. The "sole issue" is whether the midstream companies' processing fees for removing natural gas liquids from the gas extracted from the Class wells are production costs necessary to make a marketable product.

¶14 Although the Oklahoma Supreme Court has not specifically addressed whether processing costs are production costs with respect to the marketability issue, the legal analysis necessary to determine that question has been settled. See Id. ¶ 27 (explaining that the analysis for costs not previously identified as production costs, in that case, "blending" costs, "is the same as for dehydration costs"). Any "field processes necessary to create a marketable product" are not chargeable to the royalty owners. Id. ¶¶ 20 -21. "[C]ustom and usage in the industry" may inform the scope of a lessee's duty. Id . ¶ 20. However, the evidence in this record shows that such factors, if any, did not limit Key's duty to provide a marketable product at its expense.¹ If the midstream processing costs at...