Cimarex Energy Company v. Harold Chastant, Jr.

Case: 13-30049 Document: 00512330312 Page: 1 Date Filed: 08/02/2013
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
August 2, 2013
No. 13-30049
Summary Calendar Lyle W. Cayce
Clerk
CIMAREX ENERGY COMPANY,
Plaintiff - Appellee
v.
HAROLD P. CHASTANT, JR., Individually and as Trustee, on behalf of Harold
P. Chastant, Jr. Trust,
Defendant - Appellant
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HAROLD P. CHASTANT, JR., Individually and as Trustee, on behalf of Harold
P. Chastant, Jr. Trust,
Plaintiff - Appellant
v.
CIMAREX ENERGY COMPANY,
Defendant - Appellee
Appeal from the United States District Court
for the Western District of Louisiana
USDC No. 6:11-CV-1713
USDC No. 6:11-CV-2146
Before HIGGINBOTHAM, OWEN, and SOUTHWICK, Circuit Judges.
Case: 13-30049 Document: 00512330312 Page: 2 Date Filed: 08/02/2013
No. 13-30049
PER CURIAM:*
This appeal concerns a dispute between the lessor and lessee of an oil, gas,
and mineral lease on Louisiana lands. Harold P. Chastant, Jr., the lessor,
argues that Cimarex Energy Company, as lessee, owes additional royalty under
the lease as a result of financial transactions that allowed it to hedge its risk
against fluctuations in prices on production. The district court granted
summary judgment in favor of Cimarex. We AFFIRM.
FACTS
On October 15, 2002, Chastant, individually and as trustee of the Harold
P. Chastant, Jr. Trust, executed an oil, gas, and mineral lease in favor of Cash
River Exploration, Inc. The lease was later assigned to Cimarex. The lease
provided that Chastant would be paid a royalty of 1/8 of the value of the
production of oil, gas, and other minerals from the leased property, which is
calculated according to language in the lease quoted below. Cimarex engages in
hedge transactions on a portion of its oil and gas production. For that portion,
at times the price received for the minerals has been higher than that on which
the royalty to Chastant is calculated, and apparently on some occasions the price
has been lower. The royalty paid Chastant has never been adjusted based on a
different price realized through hedging.
Cimarex’s brief explains the relevant transactions this way:
Cimarex engaged in commodities futures trading of various
types as a way of hedging against the price fluctuations in oil and
gas. Hedging is generally defined as “[a] risk management strategy
used in limiting or offsetting probability or loss from fluctuations in
*
Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH CIR.
R. 47.5.4.
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the prices of commodities, currencies, or securities.” Specifically, to
“hedge” against price risk, one enters the futures market and buys
a futures contract under which he obtains a contract position that
minimizes risk against price fluctuations.
The most important point about this hedging, as it relates to
this lawsuit, is that it was a purely financial activity. Generally,
parties engaged in financial hedging are not actually buying or
selling natural gas or crude oil. Instead, they are simply buying or
selling financial positions called “derivatives,” i.e., “a financial
instrument whose value derives from the value of an underlying
asset, reference rate, or index.”1
Chastant made written demand on Cimarex that it pay royalties based on
the prices it received through entering these transactions. In a filing with the
Securities and Exchange Commission that appears in the record, Cimarex
reported that it had “executed cash flow effective hedges covering approximately
24% of [its] overall 2007 gas production and 11% of [its] 2008 gas volumes. . . .”
During a six month period in 2009, Cimarex executed derivative contracts that
“cover approximately 40% of our anticipated 2010 oil and gas production
volumes.”
Cimarex filed a declaratory judgment action in September 2011, in the
United States District Court for the Western District of Louisiana. It sought a
judicial declaration that the hedge price Cimarex received was not part of the
market value on which royalty paid to Chastant was calculated under the terms
of the lease. In response, Chastant filed suit in state court to recover a royalty
based on what Cimarex received from its hedging operations. The state suit was
removed to district court on December 13, 2011. Upon consolidation of
1
These explanations from the Cimarex brief cite various secondary authorities, but we
have omitted the sources.
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Chastant’s suit and Cimarex’s motion for declaratory judgment, both parties
filed cross motions for summary judgment; Cimarex’s motion was granted, and
Chastant’s was denied. Chastant appeals from the court’s final judgment, filed
December 20, 2012, dismissing the matter with prejudice.
DISCUSSION
A district court’s grant of summary judgment is reviewed de novo. E.g.,
Ballard v. Devon Energy Prod. Co. , L.P., 678 F.3d 360, 365 (5th Cir. 2012). “The
court shall grant summary judgment if the movant shows that there is no
genuine dispute as to any material fact and the movant is entitled to judgment
as a matter of law.” Fed. R. Civ. P. 56(a). Summary judgment is proper when,
after considering all facts and evidence in the light most favorable to the non-
movant, a reasonable jury could not find for the non-movant. Ballard, 678 F.3d
at 365. The district court’s interpretation of the parties’ mineral lease is
reviewed de novo. E.g., Travelers Ins. Co. v. Liljeberg Enters., Inc., 7 F.3d 1203,
1206 (5th Cir. 1993).
At issue is whether the lease between Cimarex and Chastant obligates
Cimarex to pay royalties on amounts it generated through separate financial
transactions in addition to the royalties it pays already on the market value of
the oil or gas produced from the property subject to the lease. The district court
properly applied Louisiana law to make this determination. Under Louisiana’s
mineral code, “[a] mineral lease is a contract by which the lessee is granted the
right to explore for and produce minerals.” LA. REV. STAT. § 31:114. The mineral
code defines “royalty” under oil and gas leases as
any interest in production, or its value, from or attributable to land
subject to a mineral lease, that is deliverable or payable to the lessor
or others entitled to share therein. Such interests in production or
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its value are “royalty,” whether created by the lease or by separate
instrument, if they comprise a part of the negotiated agreement
resulting in execution of the lease.
LA. REV. STAT. § 31:213(5).
The parties’ contractual agreement as to what constitutes royalties is
derived from the language of the mineral lease itself, as “the lease contract is the
law between the parties, defining their respective legal rights and obligations.”
Frey v. Amoco Prod. Co., 603 So. 2d 166, 172 (La. 1992); see also LA. CIV. CODE
art. 1983 (stating contracts have effect of law for parties). With respect to crude
oil, the royalty provision of the lease between Chastant and Cimarex provides:
“(a) On oil . . . one-eighth (1/8) of that produced and saved from the land . . . .
Lessee may sell Lessor’s such oil at the best market price obtainable and pay
Lessor the price received f.o.b. [“free on board”] the leased property, less any
severance of production tax imposed thereon.” As to natural gas, the lease
provides:
(b) On gas produced from or attributable to said land and sold . . .
one-eighth (1/8) of the market value at the mouth of the well of the
gas so sold . . . . The price to be used in computing the market value
at the mouth of the well shall be the price received by Lessee under
an arms’ length gas sales contract prudently negotiated in the light
of the facts and circumstances existing at the time of consummation
of such contract . . . .
Chastant first relies on the Louisiana statute requiring the lessee in a
mineral lease “to develop and operate the property leased . . . for the mutual
benefit of himself and his lessor.” LA. REV. STAT. § 31:122. Chastant then
argues that the lease provides for a fractional royalty with “no clear provision
against a fractional division of gross revenues,” meaning in effect that some
royalty would be paid as a fraction of one value and the other receive the benefit
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of the derivative trading. Chastant’s argument is simple: Cimarex owes royalty
on the total amounts it received related to production from this well.
The central difficulty for Chastant’s argument is that Cimarex’s hedging
operations do not affect the market value of those items at the well or on the
lease. That is a critical fact because the lease provides that royalties are to be
paid on the best market price of the gas at the mouth of the well or the oil on the
leased property. Consequently, the gains or losses on derivative trading, which
do not affect the price at the wellhead or on the lease, are not subject to the
lease’s royalty provision.
This conclusion is supported in general terms by long-standing Louisiana
law. For example, the lease in one case provided that the lessee “should pay one-
eighth of the ‘value of such gas’ calculated at the ‘market price,’ which means the
market price at the well or in the field and not the price which it would bring in
a distant market.” Wall v. United Gas Pub. Serv. Co., 152 So. 561, 564 (La.
1934). The Louisiana Supreme Court held “that the right of the owner of a
royalty interest is restricted to a share in production if and when it is obtained.”
Union Oil Co. of Cal. v. Touchet, 86 So. 2d 50, 53 (La. 1956). In a similar
context, the Louisiana Court of Appeals concluded post-production costs were
deductible from royalty payments because royalty payment was determined “at
the mouth of the well.” Merritt v. Sw. Elec. Power Co., 499 So. 2d 210, 214-15
(La. Ct. App. 1986). It relied on our holding that “Louisiana law arrives at the
value of the gas at the moment it seeks to escape from the wellhead.” Freeland
v. Sun Oil Co., 277 F.2d 159 (5th Cir. 1960).
We apply these legal concepts to the relevant contractual language. The
lease provides that the market value, 1/8 of which is then owed Chastant, is to
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be computed “at the mouth of the well” or “f.o.b. [free on board] the leased
property.” The provision for gas is quite specific: “The price to be used in
computing the market value at the mouth of the well shall be the price received
by Lessee under an arms’ length gas sales contract prudently negotiated in the
light of the facts and circumstances existing at the time of consummation of such
contract . . . .” There is no room in such a computation for factoring in financial
transactions entered into with the intent, but perhaps not always the effect, of
softening the effect of drops in those market prices. The value of oil is more
simply put, but we see no distinction relevant here: “the best market price
obtainable and pay Lessor the price received f.o.b. the leased property, less any
severance of production tax imposed thereon.”
The hedging activities are used to minimize the risk of market fluctuations
in the price of the oil or gas. Because the transactions are purely financial and
do not affect the market value of the oil or gas at the well or on the leased
property, the profits or losses resulting from these transactions are not subject
to the royalty provisions in the lease.
Chastant seeks to override such authority by arguing that a more recent
Louisiana case supports that the hedging transactions are part of the market
value subject to the lease’s royalty provision. See Frey, 603 So. 2d 166 (La.
1992). In that case, royalties were due as a result of the lessee’s sale of gas to a
third party under a take-or-pay provision. Id. at 169-79. A take-or-pay provision
in a contract requires a “purchaser to take, or failing to take, to pay for the
minimum annual contract volume of gas which the producer-seller has available
for delivery.” 8 HOWARD R. WILLIAMS & CHARLES J. MEYERS, OIL AND GAS LAW
1038 (2012). The district court correctly explained that this decision is
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inapplicable, stating that “the Frey court specifically held that the take-or-pay
payments were part of the ‘amount realized’ under the terms of the lease at
issue, and reaffirmed the well-settled principle that ‘the right of the owner of a
royalty interest is restricted to a share in production if and when it is obtained.’”
Frey provides no legal basis for Chastant’s position. Take-or-pay is, for these
purposes, an alternative to actual production, or effectively a minimum
production for purposes of rights under the lease. Hedging transactions do not
serve that purpose. They are supplements to production, not substitutes.
The mineral lease is clear as to how royalties are to be paid. Royalties on
oil are to be paid on “the best market price obtainable” for the price received
“f.o.b. the leased property,” while royalties on gas are to be paid on “the market
price at the mouth of the well.” That clarity stops a court from interpreting the
agreement beyond its plain language. “When the words of a contract are clear
and explicit and lead to no absurd consequences, no further interpretation may
be made in search of the parties’ intent.” LA. CIV. CODE art. 2046.
In summary, the mineral lease between Cimarex and Chastant does not
require Cimarex to pay royalties on amounts generated through its separate
financial activities. What is owed is calculated on the market value at the
mouth of the well or leased property.
AFFIRMED.
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