## Facts

- Oil Producers, Inc. of Kansas (OPIK) operated wells under 25 Kansas oil and gas leases executed between 1944 and 1991 requiring royalties on gas “sold at the wellhead,” generally at a 1/8 rate.
- OPIK sold raw, unprocessed natural gas at or near the wellhead to third-party purchasers under gas purchase contracts.
- Purchasers, not OPIK, then gathered, compressed, dehydrated, treated, and processed the gas to meet downstream specifications and extracted/sold natural gas liquids (NGLs).
- The contract price to OPIK used a netback-style formula: starting from downstream revenues for processed gas and NGLs and deducting specified costs and adjustments (e.g., gathering, compression, processing, transportation, fuel, line loss) to impute a wellhead value.
- OPIK paid royalties based on this imputed wellhead value.
- A certified class of royalty owners alleged Kansas’s marketable-condition rule required OPIK to bear all costs necessary to make gas “marketable,” asserting gas is not marketable until processed to pipeline quality, so the deductions unlawfully reduced royalties.

## Issues

1. Under Kansas’s implied duty to market and marketable-condition rule, when gas is sold at the wellhead in a good-faith transaction, is gas “marketable” once it is acceptable to the purchaser, or only after it is processed to downstream pipeline quality?
2. If the gas is marketable at the wellhead sale, may royalty calculations reflect post-sale deductions embedded in the purchase-price formula, or must the operator bear those costs as a matter of law?

## Decision

- The Kansas Supreme Court reversed the Court of Appeals and the district court and remanded.
- The court held that production is merchantable once the operator delivers gas in a condition acceptable to a purchaser in a good-faith transaction, which may occur at the wellhead.
- The court rejected a categorical rule that gas must meet interstate pipeline quality before it is considered marketable.
- Because the class’s legal theory treated all downstream costs to reach pipeline quality as the operator’s responsibility as a matter of law, summary judgment for the class was error.

## Legal Principles

- A lessee has an implied duty to market production on reasonable terms within a reasonable time after production.
- If production is unmerchantable in its natural form, the lessee must prepare it for market, free of cost to royalty owners, until it becomes merchantable.
- Production becomes merchantable when it is in a condition acceptable to a purchaser in a good-faith transaction; marketability is not defined by a fixed requirement of pipeline-quality gas.
- Where gas is sold at the wellhead in good faith and royalties are based on those sales, Kansas law does not require the operator, as a matter of law, to bear all post-sale costs reflected in a netback pricing formula.

## Conclusion

The Kansas Supreme Court held that a bona fide wellhead sale can satisfy the implied duty to market because gas is marketable once it is acceptable to a good-faith purchaser, not only when processed to pipeline quality; therefore, royalty owners were not entitled to summary judgment on a theory that all downstream costs must be borne solely by the operator.


Fawcett v. Oil Producers, Inc. of Kan., 302 Kan. 350, 352 P.3d 1032 (Kan. 2015)