Scofield v. La Gloria Oil & Gas Co.

TUTTLE, Circuit Judge.

This appeal presents the question whether La Gloria Oil and Gas Company is entitled to the statutory depletion allowance of 27%% of its gross profits from the sale of certain heavier hydrocarbons it extracted from wet gas delivered to it for such extraction and recycling by owners of the gas. The answer to this question depends upon whether the complex contractual relations between La Gloria and the owners of the leasehold interests in the gas created in La Gloria an economic interest in the minerals in place, and, if so, whether the entire income from the sale of the heavy hydrocarbons is a part of the production and thus “income from the property” or in part is a result of processing, subsequent to the completion of production.

We decide the first question in the negative, and thus do not reach the second.

The statutory basis for the depletion for the years in question is to be found in Section 23(m) and in Section 114(b) (3) of the Internal Revenue Code of 1939.¹

The facts giving rise to the litigation here are not in dispute. Although complex, they must be understood precisely before the court can match them with other situations on which the courts have heretofore acted. As here reproduced, the statement is taken largely from the taxpayers’ brief. The statement, however, includes some matters which are undisputed, but not included in taxpayers’ recitation.

In 1940, certain oil and gas companies and individuals owned interests in undeveloped oil and gas leases in the La Gloria Field area. The La Gloria Field area is a multiple-sand oil and gas field in Jim Wells and Brooks Counties, Texas. This area includes the “La Gloria Unit,” the “South La Gloria Unit,” and the “Moos Unit.” The thirty-five producing zones of this field contain reserves of oil and natural gas; approximately 94% of the natural gas consists of the lighter hydrocarbon compound of methane and approximately 6% thereof consists of heavier hydrocarbon compounds. Each of these hydrocarbon compounds exists in a natural vapor state in high pressure reservoirs.

Prior to June 4, 1940, (the date of the first contract with which we are here concerned) five exploratory wells had been drilled in the field of Magnolia, et al., and established the existence of the hydrocarbon compounds in some of the reservoirs underlying a portion of certain leases. There existed the contingent possibility that the drilling of a number of additional wells would develop substantial reserves of additional hydrocarbon compounds.

Insofar as the La Gloria Field was concerned, there existed no available substantial market for methane, but there did exist available markets for some of the heavier hydrocarbon compounds. Under the conservation laws of Texas, production of natural gas from the La Gloria Field, and the separation therefrom of the heavier hydrocarbon compounds, followed by the flaring of the residue gas (methane) would have constituted physical waste and would not have been permitted. Therefore, the only existing feasible means of producing an economic return from the natural gas reserves was a method of separating the marketable heavier hydrocarbon compounds from the natural gas and then returning the remaining residue to the gas producing formations. The common method of producing and separating such hydrocarbons is cycling, which is the process for producing the maximum quantity of heavy hydrocarbons contained in the high pressure gas in gas reservoirs.

Not only was this production procedure necessary to prevent the waste of the residue gas, but the injection of the residue gas was necessary to maintain pressure in the reservoir. If the reservoir pressure was not maintained by cycling (the only method available), retrograde condensation would occur.

Retrograde condensation is a natural phenomenon that only occurs in high pressure gas reservoirs above a pressure of 1200 pounds.

Through cycling, La Gloria will be able to recover 8,800,000 barrels of heavier hydrocarbons that otherwise would have been lost by retrograde condensation.

Through the medium of an instrument dated June 4, 1940, La Gloria entered into a legal relationship with Magnolia Petroleum Company, et al., the then owners of undeveloped gas leaseholds in the La Gloria Field. The general substance and economic effect of such instrument was as follows:

(1) La Gloria would use its best efforts to unitize the participating area.

(2) Upon obtaining requisite unitization agreement, La Gloria at its expense would construct- a cycling plant equipped with necessary appliances, gathering and return lines, with capacity of 150,-000,000 cubic feet of gas per day, designed and constructed to process gas for the recovery of natural gasoline, condensate and other products and to return the residue gas (methane) at high pressure into the producing formations. To the extent of 150,000,000 cubic feet of gas per day the plant was exclusively dedicated to the participating area of Magnolia, et al.

(3) At the time operations were commenced for the construction of the cycling plant, La Gloria at its initial expense, would drill and equip a sufficient number of gas wells (not exceeding 20), the number and location and specifications to be determined by Magnolia, to enable production of 150,000,000 cubic feet of gas per day and input wells for the return of gas to the producing formations. La Gloria was to be repaid for such well costs from Magnolia’s share of production.

(4) When the cycling plant was ready for operation, La Gloria agreed to operate the plant, take and process the gas for the recovery of heavier hydrocarbons, and to return the residue gas (methane) into the producing formations through input wells furnished by Magnolia, and to continue such taking and processing and return of residue gas during the life of the agreement with the exception that La Gloria could but was not obligated to take gas having less than specified minimum GPM content. The term of the agreement was for the life of the leases, with La Gloria having the right to suspend operations if production diminished below, and was not thereafter increased to, a designated minimum quantity. Under stated conditions La Gloria could process gas of others not parties to the contract.

(5) In consideration of La Gloria’s investment and undertakings it acquired 50% of the heavier hydrocarbons “contained in all gas to be produced from” said leases.

Through the medium of an -instrument dated June 16, 1941, La Gloria entered into a further legal relationship with Magnolia Petroleum Company, et al. (different owners from the first contract), the then owners of other undeveloped gas leaseholds in the South La Gloria Field. Through the medium of an instrument dated May 31, 1943, La Gloria entered into a legal relationship with The Texas Company, et al., the then owners of other undeveloped gas leaseholds in the Moos Unit. The general substance and economic effect of both instruments is similar to that stated with reference to the first instrument, dated June 4, 1940.

La Gloria on October 24,1940, obtained from the Railroad Commission of Texas a special order permitting recycling (cycling) of gas in the La Gloria Field. The Commission found that “the proposed plan for recycling will not result in physical waste, but will permit the recovery of a greater volume of liquid products.”

Pursuant to such legal relationships La Gloria secured execution of unitization agreements, constructed its natural gas cycling plant with requisite processing facilities, compressors, gathering lines, return lines and meter stations, and constructed additions to and expansions of such facilities, caused sixteen gas wells to be drilled and equipped in the field; all of which expenditures aggregated approximately $5,452,000. It was reimbursed from the owners’ share of the minerals for the cost of drilling and equipping the wells.

The flow of the gas in the cycling process is summarized as follows: The high pressure gas was produced from the reservoir up through the well bore through the producing well, through the gathering lines into the plant, the heavier hydrocarbons were removed in the plant, the residue gas (methane) coming out of the plant was compressed to a pressure higher than the reservoir pressure, flowed from the compressors back through the return line into the injection well down through the well bore, back into the reservoir, and the dry injected gas displaced and swept the wet gas containing the heavier hydrocarbons in the reservoir toward the producing well.

An accurate but simplified description of the flow of gas and the hydrocarbon compounds in the separation facilities may be summarized as follows: The wet field gas flowed through the coolers, through regulators where a pressure drop was taken, into separators where as a result of change in pressure and temperature a portion of the heavier hydrocarbons fell out as a liquid by gravity and flowed to the raw feed tanks. The gas containing the remainder of the heavier hydrocarbons flowed from the separators into absorbers, and there came into contact with absorption oil; the additional hydrocarbons were scrubbed out of the gas by going into solution with the absorption oil, which may then be designated as rich oil. By application of heat the heavier hydrocarbons were removed from the rich oil and flowed into the raw feed tank; the dry gas or methane flowed out of the absorbers to the compressors.

From the raw feed tank flowed a commingled stream of the heavier hydrocarbons recovered from the separators and in the absorbers; these compounds flowed through fractionators where the commingled stream of heavier hydrocarbon compounds were divided into respective separate compounds. The heavier hydrocarbons existed in a vaporous phase in the reservoir and were in a liquid phase as recovered in the plant with no chemical change in the composition of the respective heavier hydrocarbons as they existed in the reservoir and as they existed after recovery in the plant.

In addition to the foregoing facts it is undisputed that La Gloria obtained a contractor to drill the wells by the assignment of such part of its right to repayment for costs by Magnolia as necessary for this purpose; it obtained the necessary equipment to equip the wells by a similar assignment to an equipment supplier, to which, however, La Gloria also pledged its credit; it obtained the necessary financing for the drilling and equipment of the wells by pledging a share of its interests to a bank. It lost the differential between 4%, which it received by way of recoupment, and 6% interest it paid to the equipment dealer for a part of the period.

As to its income tax return for the years 1947 through 1951, La Gloria’s deductions of 27Yz % depletion from its income from sale of its 50% interest in the heavier hydrocarbons it extracted and sold were disallowed by the Commissioner. The taxpayer paid the tax and sued in the district court for refund.

Upon a finding of the facts substantially as set out above, the trial court concluded that the taxpayer was entitled to the depletion allowance on its entire income from the sale of heavier hydrocarbons.

The court made no findings on the point, but it was undisputed that some twenty per cent, of the total sales by La Gloria (these were not included in those as to which depletion was claimed) were of heavier hydrocarbons of identical kinds from gas furnished to La Gloria by others than the three production units mentioned and processed by it for such owners.

In its findings of fact the trial court (171 F.Supp. 624] stated that the construction costs of the plant and gathering pipe lines and metering stations constituted “a capital investment in the liquid hydrocarbons.” The court then made a finding of facts as follows:

“The only source that La Gloria had to recoup its capital investment, described above, was from its share of the hydrocarbons produced and La Gloria was dependent solely upon the production of such hydrocarbons from the realization of its interests in the hydrocarbons in place.”

Before further discussion of the case, it must be pointed oat, because it goes to one of the essential tests of depletability of income, that if this finding means that “the only source that La Gloria had to recoup its capital investment * * * was from its share of the hydrocarbons produced from the units” then it is demonstrably in error. As we have stated, twenty per cent, of the gross income from the La Gloria plant comes from the extraction and sale of hydrocarbons from gas entirely unrelated to these three units. Obviously, therefore, the value of the capital investment in the plant would be recouped from the outside sources as well as from the three units here involved. If, on the other hand, the trial court did not mean his finding to say that the source of recoupment was from the hydrocarbons produced by the three units, then the finding is of no legal significance, as will be developed later.

Both parties agree that the origin of the formula by which the courts determined whether income is subject to the percentage depletion deduction in the oil and gas industry is the Supreme Court’s opinion in Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489. There the taxpayer, a lessee of certain oil and gas properties, had transferred his interest in these properties to two oil companies in return for a cash bonus, a future payment to be made “out of one-half of the first oil produced and saved,” and an additional royalty of one-eighth of the oil produced and saved. In upholding the taxpayer’s right to depletion on all three types of payments, the court based its decision on the grounds that a taxpayer is entitled to depletion where he has (1) “acquired, by investment, any interest in the oil in place,” and (2) “[secured] by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital.” 287 U.S. 551, 557, 53 S.Ct. 225.

Both parties also agree that the last word on this complex subject is that spoken by the Supreme Court in the recent case of Commissioner of Internal Revenue v. Southwest Exploration Co., 350 U.S. 308, 76 S.Ct. 395, 398, 100 L.Ed. 347. In that case, two taxpayers were in dispute as to which was entitled to the depletion. Southwest had acquired from the State of California, by bid, leases on certain offshore oil deposits. It was a condition of the lease that all drilling must be done from the shore instead of vertically over the deposits. As a condition to the lease Southwest was required to show, as it did, an effective agreement permitting the drilling of the wells from the surface of upland owners. These owners, Huntington Beach Company, et al., had executed such agreement, including the right of ingress and egress and the usual provisions for use of the surface as needed, and in return Southwest contracted to pay Huntington 24%% of its net profits from the oil deposits. Both Huntington and Southwest claimed the right to depletion as to this 24% % of the income.

The Supreme Court held that Huntington, the upland owner, was entitled to the allowance. The Court briefly traced the history of its decisions in this area and, after quoting the formula from Palmer v. Bender, set out above, commented :

“These two factors, usually considered together, constitute the requirement of ‘an economic interest.’ This Court has found the requisite interest in the oil in place to have been retained by the assignor of an oil lease, Thomas v. Perkins, 301 U. S. 655, 57 S.Ct. 911, 81 L.Ed. 1324, * * * and the grantor of oil lands considered as an assignor of drilling rights, Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25, 66 S. Ct. 861, 90 L.Ed. 1062. The Court found no such interest in the case of a processor of natural gas who had only contracted to buy gas after extraction, Helvering v. Bankline Oil Co., 303 U.S. 362, 58 S.Ct. 616, 82 L.Ed. 897, and in the case of a former stockholder who had traded his shares in a corporation which owned oil leases for a share of net income from production of the leased wells, Helvering v. O’Donnell, 303 U.S. 370, 58 S.Ct. 619, 82 L.Ed. 903.

“The second factor has been interpreted to mean that the taxpayer must look solely to the extraction of oil or gas for a return of his capital, and depletion has been denied where the payments were not dependent on production, Helvering v. Elbe Oil Land Development Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904, or where payments might have been made from a sale of any part of the fee interest as well as from production. Anderson v. Helvering, 310 U.S. 404, 60 S.Ct. 952, 84 L.Ed. 1277.

It is not seriously disputed here that this requirement has been met. The problem revolves around the requirement of an interest in the oil in place.

“It is to be noted that in each of the prior cases where the taxpayer has had a sufficient economic interest to entitle him to depletion, he has once had at least a fee or leasehold in the oil-producing properties themselves. No prior depletion case decided by this Court has presented a situation analogous to that here, where a fee owner of adjoining lands necessary to the extraction of oil is claiming a depletion allowance.” (Emphasis added.)

The Court found that Huntington had the requisite economic interest in the oil in place, saying:

“ * * * Proximity to the offshore oil deposits and effect of the state law combined to make the upland owners essential parties to any drilling operations. This controlling position greatly enhanced the value of their land when extraction of oil from the State’s offshore fields became a possibility. The owners might have realized this value by selling their interest for a stated sum and no problem of depletion would have been presented. But instead they chose to contribute the use of their land in return for rental based on a share of net profits. This contribution was an investment in the oil in place sufficient to establish their economic interest. Their income was dependent entirely on production, and the value of their interest decreased with each barrel of oil produced. No more is required by any of the earlier cases.”

And finally, in language that is of extreme significance here because La Gloria is a “stranger” “disassociated from the lease,” the Court concluded the opinion:

“Southwest contends, finally, that if depletion is allowed to the upland owners in this case, it would be difficult to limit the principle in instances of strangers ‘disassociated from the lease’ who may have contributed an essential facility to the drilling operation in return for a share of the net profits. But those problems are not before us in this case where the upland owners could hardly be said to be ‘disassociated from the lease.’ We decide only that where, in the circumstances of this case, a party essential to the drilling for and extraction of oil has made an indispensable contribution of the use of real property adjacent to the oil deposits in return for a share in the net profits from the production of oil, that party has an economic interest which entitles him to depletion on the income thus received.” (Emphasis added.)

We have quoted so fully from this opinion, partly because it is the last expression of the Court on this very question, but largely also because taxpayer lays heavy stress on it as requiring a decision in its favor.

The Government, not at all disturbed at such reliance by La Gloria, nevertheless stresses Helvering v. Bankline Oil Co., 303 U.S. 362, 58 S.Ct. 616, 618, 82 L.Ed. 897, as setting forth the true principles on which the decision here must depend. In Bankline, the taxpayer, also a stranger to the lease, had contracted, in return for a two-thirds share in the salable gasoline extracted by it from wet gas delivered to its gathering pipes by the producer, to build the necessary plant and facilities that would receive the wet gas and process it in somewhat similar fashion to that used here to extract the heavy hydrocarbons, and sell the gasoline thus extracted for its account and for the account of the producer on the basis of two-thirds and one-third. Some of the residual gas was sold, some was flared and wasted, and some was returned to the wells for pressure purposes.² The taxpayer contended that its investment in the expensive plant and network of pipes, both essential to commercial development of the minerals, coupled with its acquisition of a share of the gasoline content of the gas which was the only source from which it could recover its capital investment, qualified it as having an economic Interest in the gas in place. The Court rejected this contention, saying:

“ " * * The phrase ‘economic interest’ is not to be taken as embracing a mere economic advantage derived from production, through a contractual relation to the owner, by one who has no capital investment in the mineral deposit. See Thomas v. Perkins, 301 U.S. 655, 661, 57 S.Ct. 911, 913, 81 L.Ed. 1324.” (Emphasis added.)

The Supreme Court, in Southwest Exploration, did not overrule or in any way criticize or limit its decision in Bankline. It must be taken, then, that the mere fact that a taxpayer makes a large investment in a necessary plant for the sole purpose of extracting hydrocarbons from a stream of gas, part or all of which is thereafter reintroduced in the underground reservoir under pressure, and gets its return exclusively from a share of the hydrocarbons extracted, has not thereby made a “capital investment in the mineral deposit.” Conceptually, the La Gloria case is very close to Bankline. Certainly it is much more similar than it is to Southwest Exploration. This is particularly so since the court expressed a clear caveat in Southwest Exploration lest its decision be construed as having application where the taxpayer seeking depletion is a “strangers ‘disassociated from the lease.’” [350 U.S. 308, 76 S.Ct. 400.] The fact situation there, which involved an “association” of the closest kind, in that the drilling activities and the mouth of the well were actually located on the taxpayers’ lands, cannot be equated to any dissimilar relationship, at least for the purpose of claiming it as a precedent in an entirely different situation. At least, so said the Court itself.

We must now examine carefully to see what significant facts are present here that were not before the Court in Bank-line to see whether what is conceptually the same is nevertheless technically and legally different to such degree as to give to this taxpayer this substantial tax advantage.

First, taxpayer here makes an effort to say that there was an actual conveyance of the heavier hydrocarbons in place. That and other circumstances distinguish the case of Hudson Engineering Corp. v. Commissioner, 5 Cir., 183 F.2d 180, from Bankline and from this case. The trial court held that the effect of the contracts before us was to effect a conveyance of the hydrocarbons. We cannot agree. Although the “Whereas” clause in the contracts states that the buyers are desirous of purchasing and sellers of selling “the natural gasoline, condensate and other products contained in all gas in and under and to be produced from said leases and lands,” the granting clause is significantly more restrictive. It granted “all natural gasoline, condensate and other products contained in all gas to be produced from his or its lands * * * together with the right to extract such natural gasoline * * * subject to the conditions hereby contained * *

One of the further terms of the contract provided that the wells, casing equipment and top well connections, should belong exclusively to Magnolia, the seller, and that seller should at all times have full and complete control of the operation of the wells; that each well should be equipped for delivery of gas into La Gloria’s gathering system at outlets designated by seller. Thus La Gloria had no right to enter, drill or take any gas except as delivered to it at the top well connections of the seller. Taxes on the gas in place were to be paid by the seller and not by La Gloria. Finally it was provided: “No deed of trust, mortgage, lien or other encumbrance of any kind or character whatsoever arising out of buyer’s operations shall attach to or affect Seller’s oil and gas mining leases or the production therefrom or interest therein * * The contract was also nonassignable by La Gloria, which fact, of course, is inconsistent with the nature of the interest which the owners of heretofore recognized depletable interests have held.³ We conclude that there was here no'actual conveyance of any of the minerals in place.

Next, taxpayers strongly stress the fact, which is not disputed, that unless some process very like that here provided was utilized, neither the wet gas nor any of its components could, at the time involved, have been marketed because of the regulations of the state regulatory board and because it would have constituted waste. It is contended that the sheer necessity of this operation resulted in its creating in the party furnishing the facility an economic interest in the gas in place. The fault with this argument is that the same was true with respect to the wet gas and the gasoline in the Bankline case. The court there noted that the wet gas was not salable and the only way the gasoline could be made available was by the processing done by Bankline in its expensive plant. This was not considered by the court to give the required characteristic to the contracts there.

Probably the strongest point urged on us by appellee is the significance of the return of the dry gas to the producing reservoir. Here it is undisputed that Magnolia would not have been permitted at the time in question to have opened the gas wells on its leases unless arrangements had been made to compress the gas after the heavier hydrocarbons were removed and pump it back into the reservoir under pressure to force the continued flow of wet gas to the surface. It is thus claimed that production was not complete when the stream of gas entered La Gloria’s gathering lines. The extraction of heavier hydrocarbons both at the separator and at the absorber ⁴ results from mechanical and heat processes which do not change the chemical structure of the gas. In a sense, therefore, since the gas, after losing some 6% of its content, is then returned to the ground there is production of the heavier hydrocarbons in the plant of the taxpayer. However, the mere fact that La Gloria’s extracting processes are necessary to produce the salable heavier hydrocarbons does not of itself make of its investment in the plant it builds for that purpose an investment in the minerals in place.

Moreover, even though we were to find that the circumstances here warranted a finding that La Gloria did make a capital investment in the minerals in place, there is still the insurmountable hurdle to its claim for depletion in the absence of the second factor of the formula: income derived from the extraction of the minerals, to which taxpayer must look solely for a return of his capital. Commissioner of Internal Revenue v. Southwest Exploration Co., supra.

A consideration of this factor highlights the significance of the relationship of the taxpayer seeking depletion to the fee or the leasehold. Is or has the taxpayer been in the chain of title, legal or equitable, to the mineral deposits? No case has been found where, as is true here, a taxpayer, by making substantial investment for the purpose of extracting minerals from several different producing properties, each having entirely unrelated reserves, has claimed that his investment in plant constitutes an investment in any one property. No case has been found where an investment in gross has been claimed to be an investment in definite minerals in place. Even if such could be the case, however, such an investment could not amount to the required “economic interest,” because the production from no single mineral deposit could be looked to solely for a return of the capital investment. As contrasted with the sellers under any one of the three contracts here in question whose entire investment in each gas lease becomes entirely worthless upon the extraction of the last cubic foot of gas, La Gloria is “playing the field.” It will continue to extract heavier hydrocarbons from South La Gloria field when La Gloria runs dry, and it will continue to extract them from the Moos unit when the others are exhausted; and even more relevant and significant, it has, during the tax years in question and as contemplated in the contracts themselves, obtained 20% of its gross sales proceeds from the extraction of heavier hydrocarbons of others entirely unrelated to these three producing units. Thus, the court’s finding [171 F.Supp. 624] that “the only source that La Gloria had to recoup its capital investment, described above, was from its share of the hydrocarbons produced” could not have meant “produced under these contracts or any of them,” because that was completely disproved.

Nor will it do to contend that the capital investment that is to be recouped is the minerals deposits themselves, because that would indeed be begging the very question we must decide — was there such investment as to give the taxpayer an economic interest in the minerals? In order to be such the income from the extraction of minerals must be the sole source of repayment of the capital invested. Here the taxpayer’s brief itself characterizes the investment to be recouped as the millions of dollars spent in the construction of its facilities in this language:

“(1) La Gloria acquired an interest in place by: (a) Investing and risking millions of dollars in drilling and equipping wells [recouped out of Magnolia’s share of production] and building a [sic] cycling plant facilities; * * *

“(2) La Gloria had to look solely to production for a return of its contribution because it could only recover its value from the production —when and if it came.”

The critical point here is that it did not look solely to the extraction of the minerals from any one property as to which it sought to claim depletion to recover the value of the large investment; it looked to and actually received production from a vast area, including a multiple-sand, oil and gas field containing 35 different producing zones, of which those here involved comprised only three.

Here, for purposes doubtless satisfactory to themselves, the lease owners did not make subleases or grant legal or equitable interests to La Gloria. They carefully delineated La Gloria’s rights as entitling it to all the heavier hydrocarbons to be produced and as entitling it to take delivery at the well head. La Gloria is therefore a stranger to the fee and the leaseholds. It built a plant essential to the commercial enjoyment of the lease owners of the gas in place, but it did not look to the extraction of minerals from the flow of gas from any single producing property for recoupment of its large investment. Its fortunes did not rise and fall in the same way as did the lease owners when new reservoirs were discovered or when the reservoir ran dry. Conceptually, therefore, it does not fit into the pattern of those as to whom Congress, by an act of grace, Helvering v. Bankline Oil Co., 303 U.S. 362, 367, 58 S.Ct. 616, 82 L.Ed. 897, has permitted the depletion deduction. Logically and traditionally it does not either. No decided case warrants the extension of the “expanding concept” of depletion to such new lengths.⁵

We conclude that the judgment must be reversed and the case remanded for entry of judgment for the Collector.

1 . “§ 23. Deductions from gross income. “In computing net income there shall be allowed as deductions:

* * * * * *

“(m) Depletion. In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary * * *. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each.” 26 U.S.C. 1952 ed„ § 23.

Ҥ .114. Basis for depreciation and depletion.

* * * * * * *

“(b) Basis for depletion.—

* * * * * * *

(3) Percentage depletion for oil and gas wells. “In the case of oil and gas wells the allowance for depletion under section 23 (m) shall be 27% per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property * * *.” 26 U.S.C. 1952 ed„ § 114.

2 . Taxpayers here belabor the point that the Bankline record is silent as to there being any contractual obligation on the part of Bankline to compress the gas for reintroduction into the reservoir. Since, however, it seems elementary that gas could not be returned to the reservoir to force the continued flow of the wet gas to the surface unless returned under a pressure greater than that present underground, it is clear that at least as to such part of the stream of gas as was processed and returned to the wells, the taxpayers’ argument here that its extraction of heavier hydrocarbons was a part of production because the stream is still to be reintroduced into the ground for pressure purposes, would be equally valid in Bankline.

3 . Note what was said by the Court in Southwest Exploration: “It is to be noted that in each of the prior cases where the taxpayer has had a sufficient economic interest to entitle him to depletion, he has once had at least a fee or leasehold in the oil-producing properties themselves.” [350 U.S. 308, 76 S.Ct. 399.]

4 . La Gloria contended that extraction continued at the fractionator. The parties stipulated that if it is decided that La Gloria is entitled to depletion on that portion of its income from the sale of hydrocarbons recovered in and attributable to the separation and absorption facilities (exclusive of the division of such compounds in the fractionator facilities), then that portion amounts to 86%% of the income. Were we to reach that point, we would hold that all extraction is concluded before the fractionator process and the maximum recovery would be 86% % of the amount in suit.

5 . In a thoughtful and thorough article, “The Economic Interest — An Expanding Concept,” Professor Joseph T. Sneed, then of the University of Texas Daw School, now of the Cornell Law School, says:

“In determining the existence of an interest in the minerals in place three basic ideas are involved, viz. the legal form or nature of the instrument, the degree of substantial ownership of the deposit possessed by the interest holder, and the extent and nature of his contribution to development and operation of the property. A [1] legal property interest in the minerals, lasting for the productive life of the property [absent here] [2] entitling its holder to significant control of the mineral deposit [lacking here] and beneficial enjoyment of income therefrom [present here] and [3] acquired as the consequence of a contribution to its development [doubtful in view of the degree of development prior to the contracts and in view of the fact that financing of the wells could be accomplished entirely but for a slight interest differential by a pledge of anticipated income] or operation [lacking here], is plainly an interest in the minerals in place. Drop one of these characteristics and the resolution of the issue is loss certain; drop two and serious doubts arise.” 35 Texas L.R., 307, 355. With two of the characteristics lacking and the third in serious doubt it would seem that even under such an Expanding Concept theory La Gloria would not qualify.