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Hitch Enterprises, Inc. v. Oxy USA Inc.

United States District Court, D. Kansas

July 16, 2019

HITCH ENTERPRISES, INC. Plaintiff,
v.
OXY USA INC., Defendant.

          MEMORANDUM AND ORDER

          ERIC F. MELGREN UNITED STATES DISTRICT JUDGE

         This matter comes before the Court on three motions: Plaintiff Hitch Enterprises, Inc.'s (“Hitch”) Motion to Certify Class (Doc. 33), Defendant Oxy USA Inc.'s (“Oxy”) Motion for Partial Summary Judgment (Doc. 66), and Hitch's Motion to Strike Expert Reports of John C. McBeath and Stephen L. Becker and Exclude Their Testimony (Doc. 57). For the following reasons, the Court denies Hitch's Motion to Certify the Class, grants in part and denies in part Oxy's Motion for Partial Summary Judgment, and denies Hitch's Motion to Strike.

         I. Factual and Procedural Background

         Hitch and the putative class are royalty owners in approximately 631 oil and gas wells located throughout Kansas. Oxy operates these wells and produces, among other things, Residue Gas, NGLs, and Helium. All the gas from these wells was comingled on the same gas lines and processed at the same location (the Jayhawk Processing Plant) under a single Processing Agreement. After processing, Oxy sold most of the Residue Gas and about half the NGLs to its affiliate, Occidental Energy Marketing, Inc. (“OEMI”), and OEMI subsequently sold those products further downstream to unaffiliated third parties. Oxy sold the Helium to ONEOK Field Service Company.

         As general background, oil and gas operators frequently perform Midstream Services- Gathering, Compression, Dehydration, Treatment, and Processing (“GCDTP”)-to prepare raw gas for market. Here, most of the gas from the putative class wells was Gathered, Compressed then delivered for Processing at the Jayhawk Processing Plant. A small percentage of the gas underwent no GCDTP services and was sold as irrigation gas or was used as house gas. The central issue in this case relates to Processing costs Oxy deducted from its royalty checks to the putative class.

         Hitch initiated this lawsuit on January 11, 2018, in the District Court of Seward County, Kansas, alleging that Oxy breached its lease with the putative class members by underpaying royalties from July 1, 2007, to April 30, 2014. Hitch was a member of a previous class action in Kansas state court-Littell v. Oxy[1]-that settled claims against Oxy for improper deductions taken for Gathering, Compression, Dehydration, and Treatment Costs prior to July 1, 2007. As a member of Littell, Hitch received a Notice of Proposed Settlement, stating:

Nothing contained in the Settlement Agreement is intended to alter or restrict OXY's ongoing practice of charging the accounts of its royalty owners with a pro-rata share of the fees and costs which it incurs to process the gas in a processing plant and to transport it on mainline transmission pipelines under approved FERC tariffs, so long as such royalty owners continue to receive the benefits of such activities in the form of their allocated share of the proceeds of sale received by OXY for the natural gas liquids, helium or other extracted products and the residue gas which is sold after such transportation and processing occur.

         In the lawsuit now before the Court, Hitch alleges two ways in which Oxy underpaid royalties. First, Oxy deducted from royalties a portion of the costs Oxy expended processing the gas. These deductions were taken in cash and in kind.[2] Hitch asserts that these deductions were impermissible because it was Oxy's sole obligation to pay all pre-sale costs necessary to make the gas marketable, including Processing costs. Second, when OEMI purchased the Residue Gas and NGLs from Oxy, OEMI paid Oxy based on a standardized Index Price. OEMI later resold those products downstream to third parties and sometimes-though not always-the weighted average sales price (“WASP”) of OEMI's third-party sales was higher than the Index Price. Oxy always calculated its royalty payments based on the Index Price. Hitch asserts, however, that it was entitled to be paid royalties on whichever was higher each month: the Index Price or OEMI's WASP.

         Hitch also brings a separate claim seeking interest on Conservation Fees that Oxy previously deducted from its royalty payments and later refunded. The Kansas Corporation Commission imposes Conservation Fees under K.S.A. § 55-166. Whether these Conservation Fees were the sole responsibility of oil and gas operators was an open question in Kansas until 2011, when the Kansas Supreme Court held in Hockett v. Trees Oil Company[3] that these fees are an expense attributable to the well operator alone.[4] In light of Hockett, Oxy refunded the wrongly withheld Conservation Fees to Hitch and the putative class. However, Oxy paid no interest on the refunded Conservation Fees, and Hitch argues that it was owed interest at 10% per annum.

         On February 2, 2018, Oxy removed this case to federal court. Hitch filed a motion with this Court to certify the following class:

All royalty owners in Kansas wells: (a) where Oxy USA Inc. was the operator (or, as a non-operator, separately marketed gas); (b) who were paid royalties for production of gas, NGLs, or Helium from July 1, 2007 to April 30, 2014; and (c) whose gas was moved over the ONEOK/West Texas Gas/NNG lines to the Jayhawk Plant for processing.
Excluded from the Class are: (1) the Office of Natural Resources Revenue, formerly known as the Mineral Management Service (Indian tribes and the United States); (2) all presiding judge(s) together with their immediate family members; (3) Oxy USA Inc. its affiliates, its predecessors-in-interest, and their respective employees, officers, and directors; and (4) royalty owners who receive royalty under the leases expressly allowing the deduction of processing expenses.

         Hitch's Motion for Class Certification included a sworn declaration by Hitch's counsel, Rex Sharp, and an Expert Report by Daniel Reineke.

         Oxy opposes class certification. Within Oxy's Response to Hitch's Motion, Oxy objected to the Sharp Declaration and the Reineke Report, asking the Court to strike both. Additionally, Oxy provided two expert reports prepared by John McBeath and Stephen Becker. Hitch objects to the McBeath and Becker reports and filed a separate motion to strike both.

         On March 11, 2019, Oxy filed a Motion for Partial Summary Judgment, seeking judgment on three claims. First, Oxy argues that the statute of limitations bars all of Hitch's claims occurring before January 11, 2013. Second, Oxy argues that Kansas law does not require Oxy to pay 10% interest on the refunded Conversation Fees. Third, Oxy argues that it paid royalties on all “field fuel” and “plant fuel.” On June 5, 2019, the Court, at the parties' request, held a hearing on these motions. The Court now rules as follows.

         II. Legal Standard

         A. Class Certification

         Class action certification is governed by Rule 23 of the Federal Rules of Civil Procedure. The Court has broad discretion in deciding whether to certify a class.[5] Under Rule 23(a), Hitch must demonstrate that: (1) the class is so numerous that joinder of all members is impracticable (numerosity); (2) there is a question of law or fact common to the class (commonality); (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class (typicality); and (4) the representative parties will fairly and adequately protect the interests of the class (adequacy). After meeting these requirements, Hitch must demonstrate that the proposed class action fits within one of the categories in Rule 23(b).

         Here, Hitch seeks certification under Rule 23(b)(3), which requires that “questions of law or fact common to class members predominate over any questions affecting only individual members” (predominance) and that a class action “is superior to other available methods for fairly and efficiently adjudicating the controversy” (superiority). The requirements of Rule 23(b)(3) ensure that a class is sufficiently cohesive to warrant adjudication by representation.[6] The predominance question asks whether common issues are more prevalent or important than non-common, individual issues.[7] “[P]redominance may be destroyed if individualized issues will overwhelm those questions common to the class.”[8]

         B. Summary Judgment

         Summary judgment is appropriate if the moving party demonstrates that there is no genuine issue as to any material fact, and the movant is entitled to judgment as a matter of law.[9] A fact is “material” when it is essential to the claim, and issues of fact are “genuine” if the proffered evidence permits a reasonable jury to decide the issue in either party's favor.[10] The movant bears the initial burden of proof, and must show the lack of evidence on an essential element of the claim.[11] The nonmovant must then bring forth specific facts showing a genuine issue for trial.[12]These facts must be clearly identified through affidavits, deposition transcripts, or incorporated exhibits-conclusory allegations alone cannot survive a motion for summary judgment.[13] The court views all evidence and reasonable inferences in the light most favorable to the party opposing summary judgment.[14]

         III. Analysis

         A. Class Certification

         Before certifying a class, the Court must undergo a “rigorous analysis” to ensure that each of Rule 23's prerequisites is satisfied.[15] Class action litigation is “an exception to the usual rule that litigation is conducted by and on behalf of the individual named parties only” and therefore “the requirements of Rule 23 are heavily scrutinized and strictly enforced.”[16] Here, Oxy disputes that Hitch can satisfy any of Rule 23(a)'s requirements except for numerosity. Oxy also disputes that Hitch can satisfy Rule 23(b)'s predominance and superiority requirements. If Oxy is correct on any of these points, Hitch's proposed class may not be certified.

         1. Marketable Condition Rule

         Much of the parties' arguments on the Rule 23 factors (commonality in particular) hinge on the Kansas Supreme Court's 2015 decision in Fawcett v. Oil Producers, Inc. of Kansas.[17]Specifically, the parties reach differing conclusions about how Fawcett changed Kansas' Marketable Condition Rule, [18] the basis for Hitch's breach of lease claim. Under the Marketable Condition Rule, oil and gas operators are obligated to bear all costs necessary to put the product in “marketable” condition.[19] Once gas is marketable, an operator may pass onto the royalty owner a proportionate share of any costs to enhance the value of the gas.[20]

         Here, it is undisputed that Oxy deducted from its royalty payments a portion of its Processing costs. Where the parties disagree is whether the Processing costs were incurred before or after the gas was “marketable.” Herein lies Fawcett's significance to this case. Hitch asserts that Fawcett introduced a new rule, whereby marketability is no longer controlled by the physical quality of the gas, but rather is determined solely by the presence of a good faith sale. Simply put: Hitch argues that under Fawcett gas is marketable only when it has been marketed. If Hitch's interpretation of Fawcett is correct, applying the Rule 23 factors in this case is relatively straightforward. It is undisputed that Oxy sold the Residue Gas, NGLs, and Helium after the gas was processed at the Jayhawk Plant. If the gas was not marketable until that sale, Oxy's deductions for Processing costs would have been in violation of its duties under the Marketable Condition Rule. And of great importance to the Rule 23 factors, under Hitch's interpretation of Fawcett Oxy's liability would be a common question with a common answer for the entire class. Given the importance of this decision on the issue of class certification, the Court begins its analysis with Fawcett.[21]

         In Fawcett, the Kansas Supreme Court reviewed a district court's order granting summary judgment on behalf of the plaintiffs. The Fawcett plaintiffs were royalty owners of 25 oil and gas leases; the defendant oil company operated the wells associated with these leases. The oil company extracted raw natural gas from the wells and sold it at the wellhead to third-party purchasers, who then processed the gas and placed it in the interstate pipeline system. The third-party purchasers paid the oil company “based on a formula that starts with the price those third parties receive[d] for the processed gas (or a published index price) [minus] certain costs incurred or adjustments made [for GCDTP services].”[22] The oil company paid royalties based on the price it received from the third-party purchasers and that price included the deductions taken for GCDTP services; thus, the plaintiffs ultimately paid a portion of the GCDTP expenses. The plaintiffs sought summary judgment against the oil company, reasoning that the GCDTP services were necessary to make the gas marketable and should therefore have been paid entirely by the oil company. The district court agreed with the plaintiffs and granted partial summary judgment for those GCDTP deductions. The Kansas Court of Appeals affirmed the district judge's order, concluding that gas is not marketable until the gas reaches mainline transmission pipeline quality.

         The Kansas Supreme Court reversed the Court of Appeals and rejected the argument that gas marketability is synonymous with interstate pipeline quality.[23] Instead, Fawcett held:

[W]hen a lease provides for royalties based on a share of proceeds from the sale of gas at the well, and the gas is sold at the well, the operator's duty to bear the expense of making the gas marketable does not, as a matter of law, extend beyond that geographical point to post-sale expenses. In other words, the duty to make gas marketable is satisfied when the operator delivers the gas to the purchaser in a condition acceptable to the purchaser in a good faith transaction.[24]

         In short: Fawcett held that once gas has been marketed (in good faith), the gas is marketable.

         This case presents a different question than Fawcett. The issue in Fawcett was whether an oil and case operator's duty to put gas into marketable condition continues after the gas is sold. The Kansas Supreme Court held that it does not. The issue here, however, is whether it is possible for gas to be in marketable condition, thus relieving the operator of further responsibility under the Marketable Condition Rule, before selling the gas. It is Hitch's position that Fawcett precludes that possibility. According to Hitch, Fawcett created the following bright-line rule: before a good faith transaction, a producer cannot deduct GCDTP expenses; after a good faith transaction, it can. Hitch's interpretation of Fawcett-under which the duty to put gas into marketable condition can be satisfied only by actually marketing the gas-would represent a significant shift in Kansas law. Upon careful consideration of Fawcett's holding and supporting rationale, the Court concludes that Hitch's interpretation of Fawcett is incorrect.

         This Court's conclusion that under Kansas law gas may be marketable before it is marketed is supported by Sternberger v. Marathon Oil Company, [25] which Fawcett cited favorably. In Sternberger, the gas in question was “marketable at the well” but no market existed at the wellhead.[26] The only way the gas could be marketed was for the defendant oil company to build its own pipeline to transport the gas to an off-site market.[27] The Sternberger Court stated that under Kansas law, “[o]nce a marketable product is obtained, reasonable costs incurred to transport or enhance the value of the marketable gas may be charged against nonworking interest owners.”[28]Thus, Sternberger represents two important points of law: (1) gas may be marketable before it is ever marketed-it may even be marketable at the wellhead-and (2) costs expended to enhance the value of gas that is already marketable may be shared with royalty owners.

         The Tenth Circuit relied on Sternberger in reasoning that gas may be marketable at the wellhead of some wells but not others:

Once gas is in marketable condition, the IDM is satisfied-regardless of whether a market exists at that location. And the Kansas Supreme Court has recognized that gas may be marketable at the well. Thus, if gas is in marketable condition at the mouth of “Well A” but not “Well B, ” [the defendant's] deductions likely would be proper for Well A's royalty owners, but a breach of the IDM for Well B's royalty owners. In other words, the propriety of [the defendant's] deductions might vary by well, depending on gas quality.[29]

         The Court recognizes that the Tenth Circuit's Roderick opinion predates Fawcett, but the Court discerns nothing from Fawcett that would negate Sternberger or Roderick on this matter. The Court therefore concludes that in Kansas gas may be in marketable condition before it is marketed in a good faith transaction. Having rejected Hitch's interpretation of Fawcett, the Court will now analyze the Rule 23 class certification factors to determine whether the class may still be certified.

         2. Rule 23

         Oxy argues that Hitch failed to show it can meet nearly all Rule 23(a) and (b)(3)'s requirements. From the Court's perspective, the biggest obstacles to certifying the class are commonality and predominance. So, the Court will begin its analysis there. Under Rule 23(a)(2), Hitch must demonstrate that there are questions of fact or law common to the putative class. In Wal-Mart Stores, Inc. v. Dukes, [30] the Supreme Court explained that Rule 23(a)(2)'s “language is easy to misread, since any competently crafted class complaint literally raises common ‘questions.' ”[31] To prove commonality the plaintiff must “demonstrate that the class members have suffered the same injury.”[32] Furthermore, a common question “must be of such a nature that it is capable of classwide resolution-which means that determination of its truth or falsity will resolve an issue that is central to the validity of each one of the claims in one stroke.”[33]

         Here, Hitch provides four nonexclusive questions of fact or law common to Hitch and the Putative Class: (1) “Whether [Hitch] and the [Putative] Class are the beneficiaries of an implied duty to market;” (2) “Whether pre-sale fuel and processing costs (in cash or in kind) were deducted from royalties;” (3) “Whether OXY (including any of its affiliates) paid royalty to [Hitch] and the [Putative] Class based on a starting price below what OXY or its affiliates received in arm's-length sales transactions;” and (4) “Whether OXY failed to fully reimburse the royalty owners for wrongfully withheld Conservation Fees by omitting 10% interest under K.S.A. [§] 60-201.”

         Oxy argues that none of Hitch's proposed questions of fact or law are meaningful because “they only focus on half of the issue in this case-how Oxy paid proposed Class members-while failing to address the equally important issue of what proposed Class members were entitled to be paid.” The Court now considers each of Hitch's proposed common questions in turn.

         a. Implied duty to market

         Oxy argues that Hitch's first proposed common question-whether the leases contain the implied duty to market-is not a question at all. Rather, “it is simply the law in Kansas that the types of leases at issue in this case include an implied duty to market.” Oxy argues that “identifying a common fact among Class members does not equate to a common question.” The Court agrees with Oxy that answering Hitch's first proposed common question will not move this case closer to resolution in any meaningful way. The pertinent question is not whether Oxy had an implied duty to create a marketable product; the question is whether Oxy violated that duty. Under Hitch's interpretation of Fawcett, Oxy's liability would be capable of classwide resolution. Hitch would need to prove only that Oxy sold virtually all the gas after it was processed at the Jayhawk Plant. If the gas is not marketable until it is sold, then Oxy clearly could not deduct any of its processing costs from its royalty payments. More importantly, there would be no need to analyze the gas quality on a well-by-well basis because all the gas from the putative class's wells was sold after the disputed Processing costs were incurred. As discussed above, the Court disagrees with Hitch's interpretation of Fawcett. So, the next question is whether commonality can be met even though the Court holds that gas may be marketable before a good faith sale.

         At the June 5 hearing, Hitch argued that even if the Court disagreed with its interpretation of Fawcett, commonality would still be satisfied because Hitch's expert witness would testify that all the gas was not in marketable condition until after Processing. Oxy, conversely, takes the position that some of the putative class gas was marketable at the well and some of the gas was not; therefore, marketability can only be determined on an individual well-by-well basis.

         Hitch directs the Court's attention to the Tenth Circuit's recent decision in Naylor Farms, Inc. v. Chaparral Energy, LLC.[34] In Naylor Farms, the Tenth Circuit, applying Oklahoma law, upheld a district court's decision to certify a class seeking damages for underpaid royalties. Hitch argues that Oklahoma has adopted the “physical quality” test to determine gas marketability that Oxy argues (and the Court agrees) is the standard in Kansas. Hitch argues that if the Court agrees with Oxy's interpretation of Fawcett, the Court should follow the reasoning in Naylor Farms.

         In Naylor Farms, the defendant operated approximately 2, 500 oil and gas wells in Oklahoma. According to the plaintiffs' allegations, the defendant attempted to circumvent the Marketable Condition Rule[35] by transferring title of the gas at the wellhead to a Midstream Services provider who performed GCDTP services, but the Midstream Services provider did not actually pay the defendant until it sold the treated gas to downstream purchasers. According to the plaintiff, the royalty owners were eventually paid royalties based on net proceeds that deducted GCDTP costs, so the royalty owners had “to bear the costs of transforming unprocessed gas into a marketable product.”[36] The plaintiff moved to certify a class of similarly-situated royalty owners.

         The defendant in Naylor Farms raised arguments similar to those Oxy raises here, specifically: does each well within the proposed class need to be analyzed individually to determine gas marketability? In answering this question, the Tenth Circuit recognized that the Oklahoma Supreme Court had not provided much guidance on this question; thus, the Tenth Circuit was tasked with predicting how the Oklahoma Supreme Court would rule. The Tenth Circuit also recognized some inconsistency in how the Oklahoma Court of Appeals had applied the Marketable Condition Rule, with one court deciding marketability based on whether the gas was suitable for “the market in which” the operator chose to participate.[37] A rule Kansas does not appear to have adopted.

         The Tenth Circuit applied Pummill's “the market in which the operator chose to participate” test in holding that the plaintiff could satisfy commonality. The plaintiff had classwide evidence that the defendant chose to participate in the high-pressure-pipeline market and that atleast one GCDTP service was required to prepare the gas for the ...


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