## Facts

- Plaintiffs owned a 4% overriding royalty interest reserved in assignments of eight federal oil and gas leases in Rio Blanco County, Colorado.
- Conoco, as assignee and working-interest owner, operated the leases and produced natural gas.
- The assignments reserving the overriding royalty were silent on who must pay post-production costs (including gathering, compression, transportation, and processing).
- Conoco deducted a proportionate share of these costs from overriding royalty payments over time, totaling hundreds of thousands of dollars.
- Plaintiffs sued in federal district court for declaratory relief and an accounting; the federal court certified a state-law question to the Colorado Supreme Court regarding cost allocation when the creating instrument is silent.

## Issues

1. When an overriding royalty assignment is silent, must the overriding royalty owner bear a proportionate share of post-production costs for gas (processing, transportation, compression)?
2. Under Colorado law, how are costs allocated between the working-interest owner and the overriding royalty owner before and after gas is placed in a marketable condition and location?

## Decision

- The Colorado Supreme Court answered the certified question by applying a two-step allocation rule.
- Conoco, as lessee/working-interest owner, must bear all costs necessary to place gas in a marketable condition and at a marketable location; such “marketability” costs are not deductible from overriding royalty payments when the instrument is silent.
- After the gas is marketable, additional costs incurred to enhance value (e.g., further processing or transportation to a higher-priced market) are shared proportionately by the working-interest owner and overriding royalty owner absent contrary agreement.
- The matter returned to the federal district court to apply this rule to specific cost items and determine any improper deductions.

## Legal Principles

- Colorado follows the marketable-product rule: the lessee’s implied duty to market includes paying costs required to obtain a first marketable product.
- Royalty and overriding royalty interests are cost-free as to expenses necessary to render production marketable, unless the parties expressly allocate those costs.
- Once gas is marketable in condition and location, subsequent post-production expenses that increase value may be charged proportionately to royalty and overriding royalty interests when the governing instrument does not provide otherwise.
- Cost classification turns on function and timing: whether an expense is required to achieve marketability versus incurred after marketability to obtain a better price or additional products.

## Conclusion

Colorado law allocates gas-related post-production costs in silence cases by requiring the working-interest owner to pay all expenses needed to make gas marketable, while permitting proportional charging of post-marketability, value-enhancing costs to overriding royalty owners.


Garman v. Conoco, Inc., 886 P.2d 652 (Colo. 1994)