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TRANSCONTINENTAL GAS PIPE LINE CORPORATION v. THE STATE OIL & GAS BOARD OF MISSISSIPPI and COASTAL EXPLORATION

SEPTEMBER 05, 1984

TRANSCONTINENTAL GAS PIPE LINE CORPORATION
v.
THE STATE OIL & GAS BOARD OF MISSISSIPPI and COASTAL EXPLORATION, INC., et al.



BEFORE ROY NOBLE LEE, P.J., ROBERTSON, AND SULLIVAN, JJ.

ROBERTSON, JUSTICE, FOR THE COURT:

I. Introduction

This appeal arises out of a controversy regarding well head sales of natural gas produced in Marion County, Mississippi. This litigation has been conducted in the context of tensions created by collisions among basic principles of geology, economics and law when applied in a context where each litigant pursues self-interest.

 The geological phenomenon of drainage necessitates, if considerations of fairness undergird our law, a rule that requires that a purchaser of natural gas (generally an interstate pipeline) take ratably from a common source of supply. That purchaser must market that gas, and the advent of deregulation has presented him with new and largely unanticipated difficulties in that regard. The natural gas market has become glutted. Prices consumers are willing to pay have fallen sharply.

 Overlaid upon these tensions are those inherent within our federal system. Until 1978 the federal sovereign

 indisputably had preempted all state regulation of wellhead sales of natural gas. Today we are presented a question of first impression: whether the Natural Gas Policy Act of 1978 (NGPA) 15 U.S.C. 3301, et seq., continues in effect this federal preemption with respect to wellhead sales of deregulated natural gas. A complementary proposition suggests that the regulatory efforts of the State Oil and Gas Board constitute an impermissible burden on interstate commerce proscribed under long-established Commerce Clause jurisprudence.

 Below we reject these and other claims advanced under federal law. We find, furthermore, that the State Oil and Gas Board has acted well within its statutory authority in requiring that an interstate pipeline take ratably (if it takes at all) the natural gas produced from a common source of supply.

 The State Oil and Gas Board has acted beyond its authority, however, insofar as it has proscribed differentials in wellhead prices. No act of the Legislature of this state authorizes regulation or control of the price paid for natural gas at the wellhead. More specifically, no enactment of the Legislature vests in the State Oil and Gas Board any authority to regulate such prices.

 Order No. 409-82 of the State Oil and Gas Board is affirmed in part and reversed in part.

 II.

 A. The Cast of Characters

 The dominant characters, corporate all, before the Court today include:

 Transcontinental Gas Pipe Line Corporation (Transco) is a Delaware corporation doing business in Mississippi. Transco is an interstate pipeline company which purchases natural gas from fields in Texas, Louisiana and Mississippi and the federal off-shore domain. Transco transports this gas from these fields and sells it to customers along its pipeline which extends from southern Texas, through Mississippi, and up the east coast as far as New York. Transco was the principal Respondent before the Oil and Gas Board and is the Appellant here.

 Coastal Exploration, Inc. (Coastal) is a Delaware corporation doing business in Mississippi. Coastal is a relatively small in-state oil and gas producer *fn1 and owns

 leasehold interests in gas-producing units in Mississippi. Coastal was the lead Petitioner below and is the lead Appellee here.

 Tomlinson Interests, Inc. (Tomlinson) is a Texas corporation doing business in Mississippi. Tomlinson is an independent oil and gas producer which operates *fn2 one of the wells here involved. Tomlinson was one of two Respondents-turned-Petitioner below and is one of the Appellees here.

 Getty Oil Company (Getty) is a Delaware corporation doing business in Mississippi. Getty is an oil and gas producer which operates three of the wells here involved. Getty was the other Respondent-turned-Petitioner below and is one of the Appellees here.

 Supporting actors, all Petitioners before the Board, include:

 Wiley Fairchild and Rodney Fairchild (Fairchilds) are adult resident citizens of Forrest County, Mississippi, each of whom owns an individual working interest in one of the wells here involved.

 W. R. Fairchild Construction Company, Ltd. (Fairchilds) is a Mississippi corporation domiciled in Forrest County, Mississippi, and owns an undivided working interest in one of the wells here involved.

 Susan W. Clements Lay (Lay) is an adult resident citizen of Hinds County, Mississippi, who owns an undivided working interest in one of the wells here involved.

 Lane Petroleum Corporation (Lane) is a Mississippi corporation which owns an undivided working interest in one of the wells here involved.

 Louis E. Ridgway, Jr., (Ridgway) is an adult resident citizen of Hinds County, Mississippi, who owns an undivided working interest in one of the wells here involved.

 Daniel E. Herlihy (Herlihy) is an adult resident citizen of Hinds County, Mississippi, who owns an undivided working interest in one of the wells here involved.

 Bryant M. Allen (Allen) is an adult resident citizen of Hinds County, Mississippi, who owns an undivided working interest in one of the wells here involved.

 Inexco Oil Company (Inexco) is a Delaware corporation doing business in Mississippi. Inexco is a small interest owner in four wells here involved.

 Of these supporting characters, only the Fairchilds and Inexco took any part in the formal hearing held by the State Oil and Gas Board, and only Inexco has entered its appearance and filed a brief before this Court. The others are listed because each filed with the Board an informal complaint charging Transco with failure to take ratably.

 The State Oil and Gas Board (the Board) is a party to this appeal. The Board is an administrative agency of the State of Mississippi created by virtue of Chapter 256, Miss. Laws of 1948, now codified as Miss. Code Ann. 53-1-5 (Supp. 1983), authorized in relevant part to make and enforce reasonable rules, regulations and orders protecting against abuse of the correlative rights and opportunities of each owner of oil or gas in a common source of supply and charged with the conduct of hearings such as that held September 14-16, 1982, which has generated Order No. 409-82, the Circuit Court's affirmance of which is here under attack. The Board is an Appellee here.

 B. The Drainage Phenomenon

 At the core of this case is the geological phenomenon of drainage. That phenomenon has been described by this Court in Shell Oil Company v. James, 257 So.2d 488 (Miss. 1972).

 When the pool of oil has been penetrated by a recovery well the oil and gas located in the pool move from a high pressure area to a low pressure area so that the oil and gas migrate from the property of one landowner to another. This exodus is called drainage. 257 So.2d at 494-495.

 The phenomenon has been similarly described by the Supreme Court of Kansas in Northern Natural Gas Company v. State Corporation Commission, 188 Kan. 355, 362 P.2d 599 (1961):

 While the members of this court make no claim to be experts in the science of the production of natural gas, we believe that the court may take judicial notice of the fact that where natural gas is within the earth in one common source and is under pressure, if one gas well is allowed to take gas, this will result in the pressure being lowered around the vicinity of this gas well so that the gas in the common source will tend to drain or rush to

 the vicinity of the well taking gas. The result will be that the other wells in the common field or source will be able to produce much less gas and the owners of such wells will have suffered a definite loss. 188 Kan. at 358, 362 P.2d at 602

 In recognition of the relatively helpless position of the party whose gas is being drained, our law has moved to ameliorate the injustice produced by drainage. Such is the genesis of Statewide Rule 48 promulgated by the State Oil and Gas Board over 30 years ago on November 19, 1951. That rule provides

 RULE 48. Ratable Take.

 Each person now or hereafter engaged in the business of purchasing oil or gas from owners, operators, or producers shall purchase without discrimination in favor of one owner, operator, or producer against another in the same common source of supply.

 Questions regarding the meaning, validity and enforceability of Rule 48 are at the center of this case.

 Drainage has spawned much litigation in this state. All prior litigation appears to have arisen in the context of one owner of an undivided interest suing another such owner with the plaintiff claiming that the defendant was taking, i.e., draining, the plaintiff's gas. Shell Oil Company v. James, 257 So.2d 488, 490 (Miss. 1971); see generally, Comment, Implied Covenant To Protect Leased Premises From Drainage, Etc., 35 Miss. L.J. 280, 280-95 (1964) (basis for suits between individuals); Kuntz, Correlative Rights In Oil and Gas, 30 Miss. L.J. 1, 1-9 (1958) (same). Insofar as we can ascertain, this is the first time a court of this state has been called upon to consider Rule 48 or in any other context to grant relief against a purchaser of natural gas for drainage loss. See In Re Petition of Cenard Oil and Gas Co., Docket No. 60-64-92, Order No. 81-64, dated April 16, 1964, (Board cited Southern Natural Gas Co. for refusal to take ratably from owners of all interests in common source of supply; apparently order was not appealed). In this and other contexts, this action plows new furrows.

 C. The Background Facts

 Greens Creek Field and East Morgantown Field are two natural gas "fields" *fn3 located in Marion County, Mississippi. Greens Creek Field was discovered by the Harkins and Company - Board of Supervisors Well in 1976. The Harper Sand Gas Pool *fn4 of that field was first encountered by the Tomlinson Interests, Inc. - J. C. Williamson Well in 1978.

 Approximately 5 miles south of the J. C. Williamson Well, Tomlinson Interests, Inc. discovered East Morgantown Field, and its Harper Sand Gas Pool, with its Board of Education Well in March, 1979. *fn5

 These two fields had been defined as separate fields by the Board by late 1980. In 1980, Getty Oil Company discovered additional Harper Sand production directly between these two fields with its Rogers 28-11 Well No. 1.

 We now know that the The Harper Sand Gas Pool underlies portions of both the Greens Creek Field and the East Morgantown Field. The two fields are contiguous. If only one well were completed into this pool and natural gas were produced from the pool via that one well, the entire pool would eventually be drained.

 At the time of the Board hearing in mid-September, 1982, there were at least six gas wells which had been completed into and which were producing from the Harper Sand Gas Pool: The Getty-Rogers 28-11 Well, the Getty-Sipp 20-9 Well, the Getty-Buckley 33-6 Well (all three operated by Getty), the Tomlinson-Willoughby 3-5 Well (operated by Tomlinson), and the Florida Exploration-Carlisle 4-2 Well and the Florida Exploration-Barnes 29-1 Well (both operated by Florida Exploration Company).

 The Harper Sand Gas Pool produced by these wells lies below 15,000 feet. All of the wells producing from this pool have been classified as "deep, high-cost wells" under Section 107(c)(1) of the Natural Gas Policy Act of 1978 (NGPA); 15 U.S.C. 3317(c)(1).

 In 1978, Transco began contracting with producers in Greens Creek Field and, on the basis of those reserves thereby committed, extended its pipeline facilities to that field. When East Morgantown Field was discovered, Transco also began entering into contracts with producers and, as a result thereof, extended its pipeline facilities to those wells to recover the dedicated reserves. Transco entered into additional contracts with producers in 1980 to cover their production where the fields merged.

 At the beginning of 1982, Transco had approximately thirty-five different contracts with various owners and producers in these two fields, including Getty and Tomlinson. These contracts had been made at various times between 1978 and 1982 and, because of different market conditions, had substantially different terms and conditions. Prior to July 1, 1982, Transco had not placed any restrictions on the

 contract owners and producers as to how much gas Transco would take under these contracts.

 Coastal owns small undivided working interests (generally less than 1%) in the units of four of the wells which produce from this pool. These are the Rogers, Sipp, Willoughby and Barnes wells. Coastal participated in the drilling of each of these wells, paid its share of drilling and completion costs, and has paid its share of operating costs for each of these wells.

 On August 6, 1980, Getty, as the operator and owner of a substantial working interest in the Getty-operated units, entered into a gas purchase contract with Transco. Among the terms of that contract was a price at the wellhead of 7.907 per one million British thermal units (mmbtu) of gas. When the wells in question first began producing gas in April 1981, beginning with production from the Sipp Well, the gas was sold to Transco.

 Many owners (including Coastal) of small undivided interest in the Getty-operated wells had no gas purchase contract when first production began. However, Getty produced all owners' gas and delivered the gas to Transco which in turn purchased and paid for all gas at the same price and on the same terms and conditions as Transco purchased and paid Getty for its gas.

 As the other wells completed into the pool began producing, the same procedure was followed, with the effect being that Transco took gas ratably as between the wells producing from the pool.

 At the outset of the year 1982, Transco held contracts for the purchase of natural gas from these six wells at prices ranging from a low of $5.00 per mmbtu to a high of $9.054. A representative sampling of those contracts includes:

 Contract Number Date Seller(s) Price

 06646 09/05/78 Tomlinson Interest, Inc. 6.511 tax

 06690 12/12/78 Harkins & Company 9.054 tax

 06695 12/12/78 First Energy Corporation "

 06696 12/12/78 St. Joe Petroleum (U.S.) "

 06707 12/12/78 Amerada Hess Corporation "

 06991 08/06/80 Getty Oil Company 7.907 tax

 61008 08/22/80 Florida Exploration Company 8.4066 tax

 61045 08/22/80 ACF Petroleum Company "

 61039 11/26/80 Southland Royalty Company 8.065 tax

 61084 03/09/81 Jones O'Brien, Incorporated 8.161 tax

 61218 12/01/81 Sabine Production Company 5.00

 61220 01/01/82 Sabine Production Company 5.00

 In the spring of 1982, Transco began to experience problems in reselling the gas on its system As the result of escalating gas costs and declining prices of competing fuel oil, end-use industrial customers of distribution companies served by Transco were switching from gas to cheaper fuel oils. By May of 1982, Transco had lost resale markets for approximately 95-100 million cubic feet of gas per day. Because the costs of gas were continuing to rise, Transco projected an additional $.65-$.70 per mmbtu increase in its average cost of gas and thus the inevitable loss of additional markets. Because it was experiencing market loss at its distribution end and was projecting further losses, Transco invoked the "market-out" provisions in all contracts containing those provisions and began paying those sellers $5.00 per mmbtu.

 Coastal Exploration, Inc. had no contract with Transco. Coastal had elected to allow Getty, Florida Exploration, and Tomlinson, the operators of the wells in which it had an interest, to sell its share of gas "under the operating agreement" . *fn6

 In May of 1982, Transco notified Getty and Tomlinson that effective June 1, 1982 (later changed to July 1, 1982), Transco would no longer take or purchase the gas of the "non-contract producers" , those owners and producers who had not entered into a gas purchase contract with Transco. However, because of certain provisions of the Florida-Transco gas contract, Transco would continue to purchase non-contract producers' gas produced from the Florida-operated wells and pay those producers the same price Transco paid Florida.

 After receiving this notice from Transco, Getty and Tomlinson notified Coastal that they, as operators, would not produce Coastal's share of gas from the Rogers, Sipp and Willoughby Wells unless Costal obtained its own gas purchase

 contract. A similar type notice was sent to other non-contract producers and owners.

 Following the notice from Getty and Tomlinson, Coastal attempted to secure another purchaser to whom it could sell its gas but was unsuccessful. In June of 1982, Coastal asked Transco to be allowed to ratify Getty's 1980 contract. Transco refused, unless Coastal would agree to amend the price to $5.00/mmbtu, to add a "market-out clause" (a clause which would allow Transco to adjust the purchase price if the contract price became "uneconomic"), and to nominate a seller's representative. Coastal rejected this offer, at which time Transco refused to take Coastal's gas at all. Coastal then filed its Petition asking the Board to require Transco to purchase its share of gas from the Getty operated wells under the same terms and conditions Transco was purchasing Getty's gas.

 Transco did not want or need any more high cost gas because of its market situation. However, in July and August of 1982, it submitted the same offer that it had already made to Tomlinson and Coastal to all non-signatory producers and owners it knew about in Getty and Tomlinson operated wells. The only difference between the 1980 Getty contract and Transco's offer was the pricing provisions and the requirement that they nominate a single seller's representative for each well. At the time of the Board hearing, 55 non-signatory producers and owners in these wells had accepted Transco's offer.

 The then-current market value of high cost gas in East Morgantown or Greens Creek Field was no more than what Transco had offered to the non-signatory producers and owners and was currently paying under its "market out" contracts, i.e., $5.00/mmbtu. *fn7

 Effective July 1, 1982, as to the Getty-Sipp and Rogers Wells, and effective August 19, 1982, as to the Tomlinson-Willoughby Well, Transco ceased to take gas attributable to the interests of any non-signatory producer or owner in the wells until and unless that producer or owner accepted Transco's $5.00 offer. As a result, Transco's takes of gas and the rates of production from the common pool by these wells were "cut back" to below the maximum efficient rate of flow of the wells. *fn8 Thereafter, for all practical purposes, the wells produced only and Transco purchased only a rate of production equal to the operators' and other signatory producers' and owners' interests in the maximum efficient rate of flow from the wells.

 The situation at the Florida-Carlisle and Barnes Wells, was different, and significantly so. Transco continued to purchase the non-signatory producers' and owners' gas which was produced from these two wells and tendered to Transco by Florida, the operator, on the same terms and conditions and at the same price which Transco paid for Florida's gas. Thus, while the Sipp, Rogers and Willoughby Wells were cut-back to below their respective allowables because of Transco's refusal to take and purchase gas, the Barnes and Carlisle Wells continued to be produced at their respective allowables because of Transco's takes and purchases of gas from those wells.

 The result of Transco's actions has been and, if allowed to continue, will be non-uniform, disproportionate and unratable withdrawals of gas from the common pool causing undue drainage between tracts of land, that is, drainage and undue drainage from the Getty and Tomlinson operated units to the Florida operated units producing from the common pool. The result of Transco's actions has also been and, if allowed to continue, will be one or more owners in the common pool producing more than their just and equitable share of the production from the pool.

 There is a second form of loss to which the nonsignatory producers and owners will be potentially subject as a result of Transco's actions. If Transco continues to take only the gas it is contractually obligated to take, the remaining gas, though still in the pool, will be much more difficult to retrieve. This is because the pressure in the pool will lower as gas is produced. In this way contracting owners such as Getty will be able to produce more than their just and equitable share of the production from the pool, absent, of course, enforcement of a requirement that contracting owners produce all owners' gas ratably.

 It should be noted that Transco was not the only pipeline purchasing gas produced by these wells. Tennessee Gas Pipe Line Co. was also a market outlet for the various owners. The relative percentages in each well under contract first to Transco, then to Tennessee, as well as the interests not under contract are shown on the following table.

 PERCENTAGE GAS REPRESENTED TO BE DEDICATED UNDER GAS PURCHASE CONTRACT

 WI Owners Who Refused to Sell To Transco & Who Are

 Transco Tennessee Still Uncommitted Balance

 Rogers 28-11 45.27489% (14) 2.35040% (8) 33.65260% (2) 18.72211%

 (Getty)

 Sipp 20-9 70.28732% (33) 9.38427% (17) 11.54930% (1) 8.77911% (Getty)

 Willoughby 3-5 53.14003% (11) 3.40061% (6) 25.66083% (11) 17.79853% (Tomlinson)

 Buckley 33-6 79.95812% (6) 11.34146% (3) -0- (0) 8.70042% (Getty)

 Carlisle 4-2 63.30590% (4) 29.61460% (9) 1.56250% (1) 5.51700% (Florida)

 Barnes 29-1 65.14900% (4) 11.61600% (11) -0- (0) 23.23500% (Florida)

 As of the Board hearing in mid-September of 1982, Tennessee was not taking any gas from these six wells. Tennessee had also refused to purchase Coastal's gas. Apparently, Tennessee viewed its market position as Transco did its.

 B. Proceedings Below

 On July 29, 1982, Coastal commenced these proceeding by filing its petition with the State Oil & Gas Board. Coastal asked that Transco be required to comply with Statewide Rule 48 by ratably taking gas from the wells producing from the common pool and purchasing without discrimination in favor of the operators, Getty and Tomlinson, against Coastal.

  The Fairchilds, owners in the Rogers 28-11 Well, joined in the Petition.

  At the hearing before the Board in mid-September 1982, Transco claimed that Statewide Rule 48 was invalid as a matter of state law and that Board had no authority to require Transco to ratably take or purchase without discrimination. Transco argued that federal law had preempted the area and that Rule 48 was unconstitutional for a variety of reasons.

  A three day trial was held before the Board during which Transco defended the action by the presentation of witnesses, exhibits and legal arguments, raising as defenses the same ...


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