CABOT CORPORATION, Petitioner, v. Martha BROWN, et al., Respondents, 754 S.W.2d 104

OPINION CAMPBELL, Justice. This oil and gas case determines the implied duty of Cabot Corporation, lessee-operator, to reasonably market gas under a lease from Martha Brown and others, lessors. Based on a jury verdict, the trial court rendered judgment for Brown awarding damages of $424,083.14 and attorney’s fees. The court of appeals affirmed the judgment of the trial court. 716 S.W.2d 656. We reverse and render in part and remand in part. Cabot is the lessee-operator of the Cabot Kelln Gas Well No. 1 (the “Kelln Well”) located in Lipscomb County, Texas.

Brown is one of several lessor-royalty owners under a 1967 oil and gas lease to Cabot. The lease required Cabot to pay royalties based on the market value of the gas at the well in the event gas was used or sold off the premises. The Kelln Well began production in 1968.

In January 1968, the lessors signed division orders which obligated Cabot to pay royalties based on the price determined by the Federal Power Commission “if such sale be subject to the Federal Power Commission.” In August 1967, Cabot and Transwestem Pipeline Company entered into a contract labeled “Exchange of Gas, Texas Panhandle.” Under the contract, the Kelln gas is transported by Cabot through its pipeline to Transwestem’s pipeline, which is part of an interstate gas transmission system extending from Texas to California.

The Kelln gas is delivered into Transwestem’s system in Roberts County, Texas, where it is measured and commingled with Tran-swestem gas to be sold in the interstate market. At that point, title to the Kelln Gas passes to Transwestern. The delivery point of the exchange gas received by Cabot from Transwestern is located in Gray County, Texas. There, Cabot takes title to an equivalent volume of gas transmitted from Transwestem’s interstate pipeline. Under the exchange agreement, Cabot pays Transwestem 2<t per MCF (thousand cubic feet) for transporting and exchanging the Kelln gas.

Under the Natural Gas Act, the FPC has jurisdiction over two broad categories of natural gas: gas being sold for resale in interstate commerce and gas being transported in interstate commerce. 15 U.S.C. § 717(b); see 15 U.S.C. § 3431. In September 1967, Cabot and Transwestem applied for and obtained a Certificate of Public Convenience and Necessity from the FPC under the Natural Gas Act of 1938, 15 U.S.C. §§ 717-717w. This certification was required for the construction of facilities and for the transportation of natural gas between the two companies.

From 1968 to 1974, Cabot used the exchange gas from Transwestem for its own use at its plant in Skellytown, Texas. However, this plant was permanently closed in 1974, and the exchange gas was rerouted to Cabot’s Kingsmill Plant in Pampa. There, the exchange gas was commingled with gas produced or purchased by Cabot from the intrastate market. The majority of this commingled gas which remained after processing was sold on the intrastate market at prices higher than the ceiling established by federal regulations.

Because this sale of commingled gases provided a basis for assertion of FPC pricing jurisdiction, Cabot sought and obtained a “Henshaw exemption.” See 15 U.S.C. § 717(c). Under this exemption, federal jurisdiction does not attach if the gas is received at the state boundary; is ultimately consumed within the state; and, is subject to regulation by a state commission, i.e. the Railroad Commission. Id. Under the Henshaw exemption, Cabot sold approximately 67% of the commingled gas at the Kingsmill Plant, for $1.35 per MCF.

Because this price exceeded the price upon which royalties were paid, Brown, in March 1981, sued Cabot claiming that Cabot had breached its duty to reasonably market the gas for the four years before the suit. Cabot had paid royalties on 38e per MCF from March 1977 to October 1980 and on 80c per MCF from October 1980 to the date of trial. Brown alleged the Kelln Gas had not been dedicated to interstate commerce, that the FPC pricing jurisdiction had not been invoked, and that Cabot had paid royalties based on a price less than market value.

Alternatively, Brown alleged that, even if the exchange amounted to a sale into interstate commerce, Cabot had an obligation under its duty to market to seek an abandonment of the exchange agreement from the FPC. By an abandonment, Cabot could have made the gas available for marketing in the intrastate market. Based on a jury finding that Cabot had failed to reasonably market the Kelln Gas, the trial court rendered judgment for Brown.

The court of appeals affirmed that judgment, holding the gas had not been dedicated to interstate commerce and the division orders signed by Brown did not alleviate Cabot’s implied duty to reasonably market. 716 S.W.2d at 659-61. Our analysis begins with a brief review of Texas law regarding duties implied in oil and gas leases. In Texas, there are three broad categories of covenants implied in all oil and gas leases. Amoco Production Co. v. Alexander, 622 S.W.2d 563, 567 (Tex.1981).

These implied covenants obligate the lessee to: (1) reasonably develop the premises, (2) protect the leasehold, and (3) manage and administer the lease. Id. Included within the covenant to manage and administer the lease is the duty to reasonably market the oil and gas produced from the premises. Amoco Production Co. v. First Baptist Church ofPyote, 579 S.W.2d 280 (Tex.Civ. App. — El Paso 1979), writ refd n.r.e per curiam, 611 S.W.2d 610 (Tex.1980); Le Cuno Oil Co. v. Smith, 306 S.W.2d 190 (Tex.Civ.App. — Texarkana 1957, writ refd n.r.e.), cert, denied, 356 U.S. 974, 78 S.Ct. 1137, 2 L.Ed.2d 1147 (1958).

This duty is also two-pronged: the lessee must market the production with due diligence and obtain the best price reasonably possible. Under a gas royalty clause providing for royalties based on market value, the lessee has an obligation to obtain the best current price reasonably available. See R. Hemingway, Law of Oil and Gas, § 8.9(

C) p. 442 (2d ed. 1983). The standard of care applied to test the performance of the lessee in marketing the gas is that of a reasonably prudent operator under the same or similar circumstances. Alexander, 622 S.W.2d at 567-68; Shell Oil Co. v. Stansbury, 410 S.W.2d 187, 188 (Tex.1966). As previously mentioned, Brown first alleges that the Kelln gas had not been dedicated to interstate commerce. As such, the FPC pricing jurisdiction had not been invoked and Cabot’s royalty payments to Brown were based on a price less than market value.

It is unnecessary for us to confront the legal question involving dedication to interstate commerce. The law with respect to division orders, set out below under Brown’s second theory of recovery, determines her entitlement to damages during the period the division orders were in effect. Under her second theory of recovery, Brown claimed that, even if the exchange was a dedication of gas to interstate commerce, Cabot had a duty as a reasonably prudent operator to seek an abandonment of its service to Transwestem.

She introduced expert testimony that a reasonably prudent operator would have sought an abandonment and that the abandonment would have been granted by the FPC. She claimed abandonment of jurisdiction by the FPC would have freed the gas from the exchange agreement and made it available for marketing at intrastate prices. Although we recognize in certain circumstances the lessee has a duty to seek favorable administrative action, e.g., Amoco Production Co. v. Alexander, 622 S.W.2d 563, 569-70 (Tex.1981), we do not reach that issue here.

As noted earlier, Brown signed division orders in January 1968, which provide royalties would be based on prices determined by the FPC “if such sale be subject to the jurisdiction of the Federal Power Commission....” We conclude that Brown is bound by the interstate prices under our holding in Exxon Corp v. Middleton, 613 S.W.2d 240 (Tex.1981). In Middleton, we held that division orders executed by royalty owners, which obligated the lessees to pay royalties at lower rates than those required under the gas royalty clauses, were nevertheless binding on the royalty owners until revoked. 613 S.W.2d at 250-51.

Brown was therefore limited to the interstate price allowed by federal regulation until the division orders were revoked. Under our Middleton holding, the division orders were not effectively revoked until Brown served Cabot with copies of her pleadings. Brown submits that Middleton is distinguishable and that the division orders did not relieve Cabot of its implied duty to market the gas, citing Amoco Production Co. v. First Baptist Church of Pyote, 579 S.W.2d 280 (Tex.Civ.App. — El Paso 1979), writ refd n.r.e. per curiam, 611 S.W.2d 610 (Tex.1980) and Le Cuno Oil Co. v.

Smith, 306 S.W.2d 190 (Tex.Civ.App. — Tex-arkana 1957, writ ref’d n.r.e.), cert, denied, 356 U.S. 974, 78 S.Ct. 1137, 2 L.Ed.2d 1147 (1958). We disagree. The Amoco Production case involved a “proceeds” royalty clause in which royalties are based upon the amount realized from the sale of gas. The court of appeals held the lessee breached its implied duty to reasonably market the gas by entering into a long-term contract with no right to future redetermination based on market value increases. 579 S.W.2d at 287.

In refusing the application for writ of error, no reversible error, we stated in a per curiam opinion that the court of appeal’s holding should not be interpreted as implying an absolute duty to sell gas at market value under a “proceeds” royalty clause. 611 S.W.2d at 610. The court of appeals further held the division orders did not purport to relieve the lessee of its duty to market the gas in good faith. However, the court did not preclude the modification of express or implied lease terms by subsequent division orders executed and binding upon the parties.

It merely stated that the particular division orders at issue, which referred to “net proceeds at the well,” did not attempt to change the basis under the lease for calculating royalty payments. 579 S.W.2d at 288. Likewise, the Le Cuno Oil case is inapplicable. In that case, the court stated generally that division orders, which provided for royalties based on the price received at the well, required the lessee to exercise good faith in any contract it entered disposing of the royalty owner’s gas. Here, there is no dispute with Cabot’s conduct in entering the 1967 contract with Transwestem.

In fact, at that time interstate prices were higher than intrastate prices, and thus the exchange contract was beneficial and profitable to Brown. The Le Cuno court concluded that the division orders were binding, and since there was no market for the gas at the well, the lessee was accountable for the amount realized less the cost of dehydration, gathering, transporting and processing. 306 S.W.2d at 193. The cases relied upon by Brown are distinguishable. Exxon Corp. v. Middleton is controlling.

Although division orders do not supplant the lease contract, they are binding between the parties “for the time and to the extent that they have been or are being acted on and made the basis of settlements and payments, and from the time that notice is given that settlements will not be made on the basis provided in them, they cease to be binding.” Exxon v. Middleton, supra. Since Brown accepted the payments, she was bound by the division order until revocation. The division order was not effectively revoked until service of process on Cabot.

Accordingly, we hold that Cabot is not liable to Brown for any damages up until the time Cabot was served. Cabot further complains of the broad form submission of the controlling issue to the jury. The only issue submitted asked: Did Cabot fail to reasonably market the Kelln gas during the period from September, 1974 to December 1, 1978? The term “to reasonably market” means to undertake such actions in marketing the Kelln gas as would a reasonably prudent operator under the same or similar circumstances, having due regard both for the interest of Cabot and plaintiffs. Answer: “Yes” or “No” Answer: Yes.

Cabot complains that the issue required the jury to assume first whether the gas was dedicated to interstate commerce, and second, whether an abandonment would have been granted, had one been sought by Cabot. As such, Cabot argues that the trial court abused its discretion by submitting an overly broad issue. We disagree. Our rules of procedure permit trial courts to submit issues in broad form. Tex.R.Civ.P. 277. Cabot’s performance as a reasonable and prudent operator is the controlling question.

Although this issue may include a combination of elements making up Brown’s theory of recovery, its submission to the jury was proper under Rule 277. While our conclusions with regard to dedication of the gas to interstate commerce and the division orders signed by Brown may impact on her recovery, we hold that the issue of reasonableness was established by the evidence and properly submitted to the jury. The trial court’s judgment included a declaratory judgment that future royalties be based on the maximum lawful price under

Section 102 of the Natural Gas Policy Act of 1978. That part of the trial court judgment is erroneous because it speculates on whether the future market value of gas will exceed the ceiling prices established by federal regulation. The trial court lacked jurisdiction to decide such a speculative question. See Fireman's Insurance Co. v. Burch 442 S.W.2d 331, 333 (Tex.1968). The parts of the court of appeals and trial court judgments declaring that Cabot is liable to Brown and the other lessors for failure to reasonably market the gas during the time the division orders were in effect are reversed.

That part of the court of appeals judgment upholding the trial court submission of the jury issue is affirmed. This cause is remanded to the trial court for the sole purpose of allowing Brown and the other lessors to establish damages, if any, commencing after the division orders were revoked by service of citation on Cabot. . The Federal Power Commission (FPC) was the predecessor to the Federal Energy Regulatory commission.